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Upside Down Mortgages and Lien Stripping in Bankruptcy

by Adam Mack, J.D.I’m upside-down in my first mortgage, not to mention my second; what can bankruptcy do about that?

All too often, I’ve seen clients who are upside-down in their mortgages thanks to the popping of the housing bubble. Many of them also had second or home equity mortgages on top of their first overwhelming home loan. These clients are usually extremely happy to hear that bankruptcy provides a powerful tool to help them make their home loan more affordable again. As I’ve discussed elsewhere, there are two types of loans: secured and unsecured. On paper, all mortgages are secured with the house or other real property acting as the security.

In a bankruptcy, however, that can sometimes be changed so the loan is unsecured; this process is called ‘lien stripping.’ To illustrate how lien stripping works, suppose a home is valued at $100,000 but the first mortgage is for $110,000 and there’s a second mortgage for $40,000. There’s so little equity in the home that the entire second mortgage is effectively unsecured. The bankruptcy code gives the chapter 13 plan the authority to “modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence.” [1] (First mortgages cannot be stripped.) Just because you’re upside down in an additional mortgage doesn’t mean that it’ll be stripped automatically. Most of the time banks that hold additional mortgages file a secured claim, which needs to be challenged.

In fact, you’ll most likely need to file what’s called an adversarial proceeding to establish the value of the home and to prove that the additional mortgage is effectively unsecured. In such a proceeding, you’ll want a qualified Kansas bankruptcy attorney going to bat for you. Remember, the purpose of bankruptcy is two-fold: to give the debtor a fresh start and to give the creditors their fair share. Most of your creditors will have attorneys to ensure that they get every cent they can. You deserve a qualified Kansas bankruptcy lawyer to make sure your rights are protected, too.

[1] 11 U.S.C. §1322(b)(2) and (3)