Bankruptcy When Second Mortgage is Underwater in Home Value
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One homeowner recently posted this question on a bankruptcy website about his second mortgage on their home: “Anyone ever negotiate a settlement on an underwater second mortgage or HELOC?”
Of course the answer is yes, but a better question might be why a homeowner would ever want or have to negotiate a settlement in the first place. For the homeowner asking the question, he revealed in his blog that they were 100% underwater on their second mortgage with a split of 80/20 between the first and second mortgage. The first mortgage was several thousand dollars underwater also.
The homeowner further wondered whether not paying the second mortgage for a couple of years might bring the second mortgage lender to the negotiating table in order to settle the loan amount and release the second mortgage lien. With the homeowner blogging on a bankruptcy forum, you would think the homeowner is at least considering the possibility of filing bankruptcy. So why would he want to know if someone ever settled a second mortgage if he is going to file bankruptcy, and why would he want to settle for the lien if he can strip it in a bankruptcy?
The answer to the last questions might be found in the type of bankruptcy the homeowner may be considering filing. Evidently the homeowner is in financial trouble struggling to make payments on his two mortgage payments, and he is looking for bankruptcy options.
The first option filing for bankruptcy protection for the individual homeowner is to file a Chapter 7 bankruptcy individually or jointly with his spouse. In a Chapter 7, secured liens cannot be stripped, and any secured lien passes through the bankruptcy in tact despite the loan amount being discharged by the bankruptcy court. Both the first and second mortgage loan amounts are discharged in the bankruptcy.
Any mortgage lien holders have the right to foreclose in order to regain their secured property after a Chapter 7 bankruptcy is closed. The second mortgage holder has nothing to gain by foreclosing on the secured property if its interest in the property is 100% underwater. They would not only not gain any money at the sheriff’s sale, but they could stand to lose the cost of foreclosing.
In the case of the homeowner in the above illustration, not paying the second mortgage holder for a while may be a good strategy if you can negotiate a settlement to get the lien removed. The second mortgage holder is not likely to file a foreclosure at this time, and the homeowner can pay the first mortgage lien holder as he goes. The first mortgage loan can be forgiven at the end of a successful Chapter 7 bankruptcy, and the second mortgage will be satisfied and lien removed if he can negotiate a successful settlement.
Another option that might resolve the second mortgage problem is for the homeowner to have enough income with a sufficient monthly disposable amount. This will allow him to jointly or individually file a Chapter 13 bankruptcy, then have the second mortgage lien stripped to an unsecured claim. After devising a 3 to 5 year plan to pay off all or a part of his debts, the lien on the second mortgage will be stripped away, and the remainder of the unsecured debts not payed will be forgiven.
Related articles
- Discharge and a Loan Modification After Bankruptcy (betterbankruptcy.com)
- Mythological Chapter 20: Is it Legal? (betterbankruptcy.com)
- Short Sale Problems and Filing a Bankruptcy (betterbankruptcy.com)
- Bankruptcy and the Mortgage Forgiveness Debt Relief Act of 2007 (betterbankruptcy.com)
