What is a Chapter 13 Mortgage Lien Strip?

Lien stripping can remove second mortgage for filers of Chapter 13 bankruptcy

Homeowners who are facing bankruptcy are often unable to keep up with their mortgage payments and may have taken out a second mortgage as they struggle to stay afloat financially.

If foreclosure is looming, they may choose to file Chapter 13 bankruptcy to halt the proceedings, which can be stopped in this type of court action regardless of how far the foreclosure has progressed.

Included in a Chapter 13 petition to the U.S. Bankruptcy Court is a powerful tool that allows consumers to remove the second mortgage. It is particularly helpful at a time when the housing crisis has caused the value of many homes to fall below the amount of their mortgages.

The practice is called lien stripping, which is now legal in every state following a recent Minnesota court decision that allows it in that state. In order for a consumer to qualify for lien stripping, the value of the house must be below the balance of the first mortgage so that the second mortgage is, in effect, not backed by any equity in the house and becomes an unsecured loan.

As part of a Chapter 13 action, in which the court orders a repayment plan for the debtor to complete over several years, the second mortgage is stripped from the home and viewed in the same way as unsecured debt, such as credit card and medical bills. Those bills are paid on a pro-rated basis through the court-ordered repayment schedule, so the amount paid on the second mortgage is a fraction of it would have been without taking advantage of the lien stripping option.

Once the Chapter 13 repayment plan is completed, and the debtor has made all the payments ordered by the court, the second mortgage lien is removed permanently from the property.

Bankruptcy attorneys at Friedman Iverson, a Minneapolis law firm, advise debtors involved in a Chapter 13 bankruptcy to be sure of the value of their homes before embarking on a lien strip.

"You will most likely need to order an appraisal of your house. But the first step is to look at your property tax appraised value," states the law firm's website. "During the housing boom, tax values used to be lower than the true value of the house. But now that housing prices are depressed, property tax appraisals are routinely higher than the appraised value of the house."

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