Bankruptcy Lien Stripping: A Comprehensive Guide for Debtors
These days, many people find themselves in a chapter 13 bankruptcy to try and stop foreclosure proceedings, especially with respect to the debtor’s principal residence. This may be simple when you have one mortgage holder to deal with, but what happens when you have multiples mortgages or equity lines? Fortunately, the bankruptcy code offers some flexible and powerful ways to deal with these subsequent liens in a process commonly known as bankruptcy lien stripping. In this article, we’ll bankruptcy lien stripping, how it works, and why someone would want to strip junior liens.
What Is Bankruptcy Lien Stripping?
Bankruptcy lien stripping, in short, refers to a process in bankruptcy cases where the debtor obtains a court order reducing the monetary value of a lien. For instance, let’s imagine a homeowner owns their home, has a primary mortgage when they bought the house, obtained a second mortgage to finance repairs on the house, and then took out a third mortgage to pay off unsecured debts, like credit cards. If a debtor can strip the third mortgage, the lien is essentially destroyed, and the debtor’s principal residence would no longer serve as collateral for that mortgage. The mortgage loan is reduced to an unsecured claim, and gets paid in a bankruptcy case the same as all other unsecured creditors.
Understanding Lien Stripping in Bankruptcy
To really understand lien stripping, it makes sense to take a step back and discuss liens, generally. There are different kinds of liens you may have heard of – judicial liens, mechanic liens, tax liens. Basically, a lien refers to a claim which is secured by property, and often the lien is something that is recorded in a county clerk’s office. A mortgage is a lien against a house because the claim is secured by the house, and the lien was recorded in the county clerk office. In New York, a money judgment may become a judicial lien after it gets recorded in the county clerk’s office. Once the judgment is recorded in the county clerk’s office, it becomes a lien against any real estate the debtor may have in that county.
It’s important to understand that if you transfer property that is subject to a lien, the party taking the property takes it subject to the lien. For instance, if a person has a home that they transfer to their child, although the name on the deed has changed, the lender can foreclose on the property if there is a default under the note. The reason is because the home was transferred with a lien against it, and the child-transferee takes the property subject to the lien.
Now that we have a sense of what liens are and how they work, you can see how powerful it can be to be able to strip mortgages and equity lines of credit. Basically, if you get a lien stripped, the holder of that lien loses the ability to foreclose or otherwise enforce the debt against the collateral.
Lien Avoidance versus Lien Stripping
While we don’t have to dive too deeply into it here, when people talk about lien stripping, they sometimes use the term interchangeably with lien avoidance. There is a difference, however. Lien avoidance is when a debtor is able to completely detach a lien from the property. This requires that the value of the property is less than the amount due on the first lien, such that if the first lien foreclosed on the property, the second lien would not receive a single dollar.
As an example, let’s consider a homeowner that has 2 mortgages on their property. The property is worth $400,000, the first mortgage claim is $500,000, and the second mortgage claim is $50,000. Let’s imagine the debtor is filing for bankruptcy to stop a foreclosure by the first mortgage holder. In the bankruptcy case (let’s assume chapter 13), the debtor can make an application to avoid the second mortgage. Why? Because if the first mortgage foreclosed on the house, the second mortgage wouldn’t receive a single dollar, it’s wholly unsecured. As a result, the debtor can request that the second lien be avoided, detaching that debt as a lien against the house, and converting it into an unsecured claim, paid just like a credit card debt or medical debt through your chapter 13 plan.
Lien stripping, on the other hand, operates to reduce the value of a lien to the current value of the property. Using the example above, of a debtor with a house valued at $400,000. In this case, however, let’s assume the amount due on the first mortgage is $350,000, and there is a second mortgage or lien of $100,000. In this instance, the debtor cannot get rid of the entire second lien (because if the first mortgage forecloses on the property, the second mortgage holder would be paid at least one dollar), but they may be able to request that the value of the second lien be reduced (or stripped down) to the equity available in the property, which would be to $50,000.
No matter which process someone is referring you, you can see how powerful bankruptcy lien stripping (and lien avoidance) is. It converts a secured claim into a partially or fully unsecured claim. This is particularly useful when someone is “upside down” on their property – that is, they owe more on the property than it’s worth.
The Difference Between Junior Liens and Senior Liens
Whenever someone is talking about junior liens or senior liens, all it refers to is the order that those creditors will be paid if the property is liquidated. If a house has two mortgages recorded against it, the first mortgage that was recorded is considered the senior mortgage, and the last recorded mortgage is considered a junior mortgage. That’s because if the house is liquidated, the first mortgage would be paid in full before the second mortgage receives a dollar.
Liens That Impair Exemptions and How They’re Treated
Diving a little deeper into lien avoidance, a debtor may seek to avoid a lien if the lien impairs an exemption. This gives the debtor a little more ammunition to potentially get rid of mortgage liens or judgment liens. As an example, let’s assume our debtor’s principal residence, which is in Queens, is worth $400,000. They have a first mortgage that is owed $300,000, and a judgment lien against them from a credit card lawsuit in the amount of $10,000. Can the judgment lien for $10,000 be avoided (and stripped off) in a bankruptcy case?
The answer is most likely yes. If we follow the logic from earlier, if the first mortgage forecloses on the house, the judgment lien would be paid in full. The debtor, however, is entitled under law, to an exemption in the equity of their principal residence. In New York City, a debtor can claim an exemption of their homestead up to $179,975. That means if the first mortgage holder forecloses on the house, any equity that exists belongs to the debtor up to $179,975. To calculate whether a lien impairs an exemption, we add the lien you want to strip ($10,000), any senior liens ($300,000 first mortgage) and any exemption the debtor would be entitled to if there were no liens on the property ($179,975), minus the value of the property ($400,000), which yields NEGATIVE $89,975. As a result, the judgment lien is impairing the exemption, and may be avoided.
The Process of Lien Stripping in Chapter 13 Bankruptcy
The process of lien stripping In chapter 13 bankruptcy is somewhat streamlined. Many bankruptcy courts have updated their chapter 13 form plan to include a provision that embeds the process in the plan, eliminating the need to file a separate motion to avoid a lien. If you aren’t sure, you may check with your local bankruptcy court to see whether you can request lien stripping or avoidance in the plan, or whether you should file a motion.
Eligibility Criteria for Lien Stripping
Before preparing a motion to avoid a lien or including such a provision in a chapter 13 plan, you will want to get an appraisal of the property at issue. If you are considering stripping a mortgage debt in a bankruptcy case, one of the first things you’ll want to do is to obtain an appraisal of the property. This is because you want to be absolutely confident in the numbers you are basing your decisions on. Relying on online valuations, such as Zillow or Homes.com, is not advised since those valuations may not be accurate, and if there is a challenge over valuation, you may need the person who valued the property to testify as to the valuation.
Once you have a reliable valuation of the property, you will need payoff letters for all the liens against the property. Assuming there is a first mortgage on the property, if the amount due to the first mortgage is greater than the value of the property, then you can likely avoid the junior liens.
Chapter 13 Bankruptcy Overview
Chapter 13 bankruptcy is a type of bankruptcy where individuals that have regular income can propose a repayment plan that pays disposable income over 3 or 5 years. Because of the flexibility of a chapter 13 case, many get to keep their personal property and household goods, along with other property like cars and homes. Since it’s a way to hit the pause button and work out a plan to get back on track, it’s a great option for someone facing a foreclosure auction or vehicle repossession.
Secured vs. Unsecured Debt: A Crucial Distinction
As we discussed previously, a secured debt is one where there is collateral is used to guarantee the payment of the claim. An unsecured debt, like credit card debt, medical debt, or a personal loan, is one where there is no lien on the debtor’s property; and the creditor can only enforce the debt against the debtor individually.
For the most part, in a chapter 13 case, secured debts must be treated alike, as do general unsecured debts. If you want to keep secured property, you must propose to pay off any arrears, as well as stay current on ongoing post-petition payments. When you file for Chapter 13 bankruptcy, understanding this difference is crucial because it affects how your debts are treated in your chapter 13 repayment plan, and really helps to forecast how successful you may be in completing your chapter 13 plan.
The Steps to Lien Stripping in Chapter 13
The path to lien stripping in Chapter 13 involves a few key steps. First, you’ll propose a chapter 13 repayment plan that includes all your debts. But here’s where it gets interesting: for junior mortgages or equity lines not fully covered by your home’s value, you can argue to avoid the lien, in which case they should be treated like unsecured debt. This is a big deal because it means these claims would no longer have the property as collateral.
Filing a Motion for Lien Stripping, or Include a Provision in Your Chapter 13 Plan
Traditionally, whenever you are seeking that the judge enter an order, the party needs to file a motion. In the past, it was no different with avoiding or stripping a lien. The debtor would have to prepare and file a motion with the bankruptcy court. The motion would be served on creditors, and there would be a date assigned for the debtor to argue why the lien should be avoided, and a creditor likely to oppose the motion.
In the last few years, many bankruptcy courts, including the bankruptcy courts here in the New York City area, have included a provision for lien avoidance in the local chapter 13 form plan. Rather than having to prepare and file a motion, a debtor can simply indicate in their chapter 13 plan that they intend to seek to avoid a lien as part of their chapter 13 case.
Appraisal and Determination Phase
Whether by motion or included in your plan, you will need to prove your case. As mentioned above, avoiding a lien requires demonstrating that the value of liens against the property are such that they exceed the value of the property, and/or they impair an exemption that the debtor can claim. As a result, information you will need to proceed with avoiding a lien include:
- an appraisal of the property;
- a payoff letter of all the liens showing the amounts due for each lien;
- making sure that you have claimed an exemption on Schedule C regarding the property, if necessary
Provided that you have this information available, you should be able to successfully request avoiding or stripping a lien in your chapter 13 case.
Payment Plan Adjustment
Depending on the amounts involved, once the lien is stripped, your payment plan might need to be modified. Remember that the avoided or stripped lien becomes unsecured debt through your chapter 13 bankruptcy plan. As a result, you may need to file an amended chapter 13 plan modifying your plan payments to account for this debt. This adjustment ensures that your plan reflects your current financial situation accurately. This step is crucial for making your bankruptcy work for you, allowing you to move forward with a lighter load and a clearer path.
When Lien Stripping Is Not Available
While the prospect of avoiding or stripping a lien in bankruptcy might seem enticing, it’s important to understand that lien stripping is not universally available in all cases, or against all liens. Therefore, individuals considering bankruptcy as a means to alleviate their financial burdens should be aware that the applicability of lien stripping depends on the type of bankruptcy filed and the specific details of their debts and property values.
Lien Stripping of a Junior Mortgage Not Available in Chapter 7 Cases
If you’re thinking about filing for Chapter 7 bankruptcy to strip a lien, think again. Lien stripping is not available in chapter 7 bankruptcies. The Supreme Court issued a decision back in 2015 holding that a chapter 7 debtor may not strip the second mortgage that was underwater against the debtor’s primpary residence.
Lien Stripping of a First Mortgage on Debtor’s Primary Residence Not Available
Lien avoidance and lien stripping are also generally not available with respect to a first mortgage that is on the debtor’s principal residence. That is, even if you are “upside down” on your first mortgage on your primary residence (the amount due on the mortgage exceeds the value of the property), you cannot avoid or strip down that lien, even in a chapter 13 bankruptcy.
The Long-term Impact of Lien Stripping on Financial Health
One thing to keep in mind is that if you’re successful in lien stripping in a chapter 13 bankruptcy is that the relief is often conditioned on successfully completing your chapter 13 plan. This is why understanding the nuances of the bankruptcy process is super important. Imagine you successfully strip a second mortgage that you owed $100,000, and because of the way your plan is structured, you only end up paying $50,000 in your chapter 13 plan to that creditor, resulting in $50,000 being discharged. To make sure you don’t end up back at square one, and have that debt revered to a lien on the debtor’s property, you must successfully complete your chapter 13 plan.
The Path After Lien Stripping
After you’ve gone through the process to strip a junior lien, like when you strip your third mortgage, that becomes nonpriority unsecured debt. Often, it’s a substantial amount that would be discharged at the end of the case, which is why you want to make sure you stay fully on top of your financial issues after obtaining an order stripping or avoiding a lien. Even if things in your financial situation change, the best thing a chapter 13 debtor can do is keep your bankruptcy attorney informed about changes, whether good or bad. If advised early enough, you and your attorney can explore all alternatives to keep the case going forward towards successful completion.
Make Navigating Your Bankruptcy Easier with a Bankruptcy Lawyer
The bankruptcy laws and filing for chapter 13 bankruptcy can be complicated enough. When you’re trying to do something advanced, like avoid a lien on a property, getting something wrong could cost you time and money. When coming into contact with attorneys for creditors, the bankruptcy trustee and the bankruptcy judge, all parties familiar with the court practice, bankruptcy can feel like navigating a new country without a map. Fortunately, you don’t have to do it alone. If you work with and hire a qualified, experienced bankruptcy attorney, like the Law Office of Richard Kistnen, you can expect transparent help to guide you through, especially when it comes to tricky parts like bankruptcy lien stripping.
Contact the Law Office of Richard Kistnen to Discuss Lien Stripping in Your Chapter 13 Case
People file bankruptcy for all kinds of reasons. A good use case for chapter 13 bankruptcy is to manage liens against the debtor’s property. If liens can be stripped, that can reduce the debtor’s financial burden by thousands, or even hundreds of thousands of dollars.
In conclusion, lien stripping can be a powerful tool for folks struggling with mortgage payments, turning a tough situation into a more manageable one. It’s like finding a hidden path to a clearer financial future. But, navigating these waters requires a skilled guide. That’s where the Law Office of Richard Kistnen comes in. Ready to explore your options and possibly lighten your load? Don’t hesitate to reach out. Better yet, click to claim your complimentary, no-obligation virtual bankruptcy consultation. Start your journey to financial relief today!