Discharging a Second Mortgage is possible in a Chapter 13 Bankruptcy. When the value of a home is less than the senior encumbrances, the bankruptcy court may find that a secured loan is unsecured and treat it as a wholly unsecured loan, and discharge the junior secured loan (commonly called a “lien-strip”).
For example, a home has a First Deed of Trust and a Second Deed of Trust. This is very common in the California housing market. Many homes were purchased with two loans the first for 80% of the purchase price and the second for the remaining 20% of the purchase price. This allowed the first loan to be a conforming loan and qualify for better terms. For this example we will assume the home was purchased for $300,000. The first deed of trust was $240,000 and the second was for $60,000. The current Fair Market Value (FMV) is $225,000. The remaining balance on the First Deed of Trust is $235,000 and the remaining balance on the second is $59,000. In a chapter 13 bankruptcy, the debtor files a Motion to Value the Collateral of the Second Deed of Trust. The Bankruptcy Court would find the collateral securing the Second Deed of Trust is $0.00 because the Senior lien, the second Deed of Trust is greater than the FMV of the property, and therefore the value of the collateral of the Second Deed of Trust is Zero. The court would calculate the value of the collateral of the Second Deed of Trust by subtracting the balance of the senior Lien from the FMV which results in a negative number. ($225,000 – $247,000 = $22,000)
The Bankruptcy Court is separated into several districts. Each Bankruptcy Court falls under a Federal District Court. In Sacramento, the Bankruptcy Court is the Eastern District of California, which is in the Federal Ninth District. The Ninth District decided a case titled In Re Lam. Lam held that a lien-strip was possible without an Adversarial Proceeding, and could be accomplished with a noticed motion. The Eastern District allows the lien-strip motion to be included in the original Chapter 13 Plan if properly noticed it will not require a separate noticed motion to accomplish. The motion is granted if there is not opposition filed to oppose the motion and confirmation of the plan.
In the current market where home values continue to decline, a potential bankruptcy debtor should consider filing a Chapter 13 if lien-stripping would make keeping their home feasible given their circumstances.
Filing Bankruptcy in Sacramento or any other Court is a complicated process. Debtors should seek competent legal advice from a qualified bankruptcy attorney before attempting to file on their own. Often Sacramento bankruptcy attorneys will allow some of the attorney fees to be paid through the chapter 13 plan. The Law Office of Peter Cianchetta makes arrangements to pay some or all of the attorney fees to be paid though the Chapter 13 plan.