In this article, we discuss how an individual or family can use a process called “lien stripping” in Chapter 13 bankruptcy to get rid of a second mortgage or HELOC and answer the following questions:
- What is a lien on a home?
- What is lien stripping?
- How does lien stripping work in Chapter 13 bankruptcy in Illinois?
- Does lien stripping make my second mortgage go away immediately?
- Is lien stripping an option with any other type of bankruptcy?
What is a Lien On a Home?
Liens come in many different forms: tax liens, municipal liens, Mechanic’s liens, and mortgage liens. Generally, alien is a security interest in a piece of real property (real estate). In situations other than a normal mortgage or HELOC a lien is usually placed on a home if the homeowners have not paid past debt owed. The entity placing the lien on the home is trying to guarantee they will at least get paid before the homeowner can sell the house, or may get paid first in the event the homeowner sells the house and has funds to pay the debt. These types of liens are known as involuntary liens.
Banks take out a lien automatically when advancing a homebuyer a mortgage. This is referred to as a voluntary lien.It is the bank’s way of securing itself against any issue the homeowner may have with payment in the future and to make sure when the homeowner sells the house the funds are used to pay off the mortgage before anything else. The homeowners are essentially placing their home as collateral in the event they cannot pay their mortgage and giving the bank the right to foreclose on the home.
What is Lien Stripping?
When people come into hard times one of the ways they can generate cash is by taking out a second mortgage on their home. This is also a common practice for business owners who need to generate some funds or collateral for their business. This process creates a senior loan and a junior loan.
Lien stripping is a tool within Chapter 13 bankruptcy that allows the homeowner to eliminate their junior lien thereby converting the junior mortgage into unsecured debt, much like medical or credit card debt. This debt is then rolled into your Chapter 13 repayment plan, but the bankruptcy filer typically only has to pay a much lower amount to satisfy the junior loan.
Lien stripping is only possible if the bankruptcy filer is “upside-down” on his or her mortgage, specifically the senior loan. Being upside down on a house means the mortgage amount is greater than the fair market value of the home.
How Does Stripping Work in Chapter 13 Bankruptcy in Illinois?
Lien stripping is only an option if the homeowner is upside on their mortgage. If the homeowner has three mortgages, with the senior mortgage being more than the current fair market value of the home the second and third mortgages can be stripped. However, if the value of the home is less than the senior mortgage (or less than the firsthand second mortgage combined) than the subsequent mortgages cannot be stripped.
Here’s an example of a mortgage situation where lien stripping could apply: The homeowner has a senior loan of$350,000 and a junior loan of $150,000. The fair market value of the home is only $300,000. In this case, the senior mortgage is worth more than the value of the home, allowing the homeowner to strip the lien on the second mortgage and convert it to unsecured debt and decreasing the amount required to satisfy the second mortgage. If the value of your first mortgage is equal to the value of your home you can usually still strip the second mortgage or if the value of your first and second mortgage are greater than the home value but you have a third mortgage you can still strip the third mortgage.
Does Lien Stripping Make My Second Mortgage Lien Go Away Immediately?
No. However, when you file Chapter 13 bankruptcy the automatic stay kicks in and going forward you won’t have to pay for the second mortgage outside of your bankruptcy repayment plan. The Lien stripping process turns your second mortgage into unsecured debt and you’ll be able to pay a much smaller amount than the original value of the loan. Once your repayment plan is completed and you've paid off the lesser stripped mortgage amount and received a discharge then the lien on your property from the second mortgage will be removed.
Is Lien Stripping an Option With Any Other Type of Bankruptcy?
As far as Illinois and Iowa are concerned Lien Stripping is only available in Chapter 13 bankruptcy. In certain situations, Alabama, Georgia and Florida allow some form of lien stripping under Chapter 7 bankruptcy. Your bankruptcy lawyer will advise you on the best form of bankruptcy for your financial situation. If you have questions about bankruptcy or are considering filing for bankruptcy give us a call at 630-324-6666 and speak with one of our experienced bankruptcy attorneys.
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