The Bankruptcy Code’s Lien-Strip Tease: The Value of Your Home and the Balance of Your Mortgages

The Supreme Court has agreed to hear two cases in which Bank of America has appealed two lower Court Rulings involving Florida homeowners which allowed the debtors in bankruptcy to lien-strip their second mortgage in a Chapter 7 filing; to date the circuit courts have been split on this issue.  A summary of the question presented from the Supreme Court Docket is shown below.  Under the current rulings in our area, specifically the 8th Circuit, which covers both Iowa and Nebraska; debtors are able to do that in Chapter 13 bankruptcy.  A Chapter 13, by contrast to a Chapter 7, is a reorganization bankruptcy which requires debtors to complete a repayment plan for 3-5 years and devote disposable monthly income to that repayment plan.  A ruling in favor of homeowners who file for Chapter 7 would allow these debtors to more easily afford their homes as they would no longer have to pay on junior mortgages when they are upside-down on the first mortgage.  Junior mortgages are 2nd or3rd or so on, these are known as a junior mortgages as they are junior to the first mortgage which holds a senior position, as the lender on the first mortgage is entitled to payment first upon sale or transfer of the home.

Lien-stripping has been a hot topic in both Chapter 7 and Chapter 13 for quite some time.   What lien-stripping does is allow homeowners who have no remaining equity to secure a junior mortgage to remove the junior mortgage upon completion of their bankruptcy. This is calculated by figuring out value of the home if they were to sell their home and satisfy the first mortgage.  For example, if your home is worth $100,000 and you have a first mortgage for $110,000 and a second mortgage for $20,000 (you owe $130,000 right now on a $100,000 home); you are able to lien-strip the second mortgage because if you were to sell your home and obtain the $100,000 your first mortgage would still be owed $10,000 and your second mortgage of $20,000 would not have any proceeds from the sale at all.  Because the first mortgage takes all or more than the value of the home, you are able to lien-strip the second mortgage upon completion of your bankruptcy.  (As the law stands right now, in the 8th Circuit, you are only able to do so in a Chapter 13 proceeding)

In order to complete a lien-strip in Nebraska and Iowa, debtors must file an adversary proceeding (lawsuit in bankruptcy), serve the lender and other interested parties and obtain a judgment in that proceeding to strip the lien.   The issue that comes into play is the value of the home and evidence as to value can be contested as well.  The attorneys at Pollak Hicks & Alhejaj have done many lien stripping adversary proceedings and would be able to advise as to whether or not this option is one available to you.  You can also be assured that we will be watching this Supreme Court matter closely to see what the outcome is and its effect on debtors in the future.

© Roxanne M. Alhejaj, Attorney at Law

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