One of the most significant powers of a Chapter 13 bankruptcy is the power to strip off a wholly unsecured second mortgage lien. If your home is worth less than the amount of the first mortgage balance, you may be able to cancel the second mortgage lien in Chapter 13. With the dramatic decline of home prices in the past few years, lien stripping actions have become much more common in the Nebraska Bankruptcy Court.
Example: Let’s assume you own a home that is worth $100,000 today, and that you owe $110,000 on the first mortgage and an additional $30,000 on a second mortgage. Because the home is worth less than the balance of the first mortgage, the entire second mortgage is unsecured and may be abolished in a Chapter 13 case. That’s right, the entire second mortgage would be eliminated. However, if the home was worth, for example, $115,000, then none of the second mortgage would be cancelled since it attaches to some of the home equity. In order for lien stripping to be successful, the debtor must prove that the second mortgage attaches to absolutely no equity in the home.
Lien stripping a second mortgage on a primary residence is authorized under Bankruptcy Code Section 506, and the relief is not available in Chapter 7 cases pursuant to the the Dewsnup Supreme Court decision. In order for the procedure to be successful, the bankruptcy filer must prove that the second mortgage does not attach to even one dollar of equity. The second mortgage must be wholly unsecured. It is generally required that the debtor prove the value of their residence by providing an appraisal. Additional evidence is provided by the County Assessor’s valuation and by reviewing sales of other homes in the area. Some cases involve a “battle of appraisals” where the mortgage company and the debtor obtain appraisals showing differing values. Ultimately, the Bankruptcy Court has the power to determine the value of the home and whether a second mortgage attaches to any equity.
In Nebraska, lien stripping requires the fling of an Adversary Proceeding in the Bankruptcy Court (See Bankruptcy Rule 7001). An adversary proceeding is basically a lawsuit filed against the mortgage company requesting the Court to determine the home’s value and the amount of the mortgage and other liens. The second mortgage company has the opportunity to respond to the adversary proceeding and may challenge the lien stripping if it feels that the debtor is understating the home’s value.
Lien stipping a second mortgage is just one example of the greater power of a Chapter 13 case in comparrison to the quick discharge process of Chapter 7.