On Wednesday, the Eleventh Circuit Court of Appeals issued an important ruling for homeowners looking to wipe out second mortgage liens in bankruptcy.
The Court's opinion in Wells Fargo v. Scantling held that homeowners can "strip off" wholly unsecured second mortgages in so-called "Chapter 20" bankruptcy cases.
How Do I Wipe Out A Mortgage in Bankruptcy?
Straight Chapter 7 bankruptcy discharges mortgage debts, meaning homeowners are no longer personally obligated to pay.
Most bankruptcies are straight Chapter 7 cases where consumers get a fresh start by keeping their assets and wiping out their debts.
However, even though a homeowner discharges mortgage debt in Chapter 7, the lender can still foreclose if the loan is in default after bankruptcy. This is because the mortgage "lien" is not affected in Chapter 7.
Chapter 13 bankruptcy discharges mortgage debts, and allows homeowners to strip off mortgage liens.
Mortgages have two components: a debt and a lien. When the debt is discharged and the lien is wiped out (the technical term is "avoided"), bankruptcy litigators call the mortgage "stripped".
Once a mortgage is stripped, it's as if it doesn't exist. A homeowner can stop payment on the debt without fear of foreclosure, and can sell the home free and clear of the mortgage.
How Do I Strip a Second Mortgage Lien?
As discussed earlier, only Chapter 13 allows homeowners to strip second mortgage liens.
In order to strip a second mortgage, the Bankruptcy Code (Section 1322(b)(2)) requires that the lien be 100% unsecured, meaning the first mortgage balance is more than the home's fair market value.
If a home is worth less than the first mortgage, bankruptcy litigators may refer to the home as "underwater", meaning the second mortgage lien-holder cannot object to a plan to avoid the lien under Section 1325(a)(5).
Why File a Chapter 20?
"Chapter 20" is a shorthand name for a homeowner who files a Chapter 13 bankruptcy after having received a prior discharge in Chapter 7. Chapter 20's are usually filed to pay off underwater vehicles for their fair market values, pay nondischargeable taxes, avoid foreclosure, and strip second mortgages.
Sometimes homeowners don't find out about lien stripping until after they've already filed a basic Chapter 7 bankruptcy. For this reason, it's important to interview bankruptcy attorneys until you find a firm with expertise and experience in filing all Chapters of bankruptcy.
In other cases, a home's value drops significantly after a Chapter 7 is filed, making it now possible to strip a second mortgage.
Other strategic reasons to file Chapter 20 exist. For instance, homeowners with large amounts of debts do not qualify for Chapter 13. The current debt limits are $1,149,525 for secured debt and $383,175 for unsecured debts. However, the homeowner can strategically file Chapter 7, discharge the debts, then qualify for Chapter 13 to strip a second mortgage.
Does My State Allow Chapter 20 Lien Stips?
Whether you can strip a second mortgage in Chapter 20 bankruptcy depends on where you live.
The following states ALLOW Chapter 20 second mortgage strips:
Alabama, Florida, Georgia (Wells Fargo v. Scantling (11th Cir. 2014)); Maryland, North Carolina, South Carolina, Virginia, West Virginia (Branigan v. Davis (4th Cir. 2013)); Oregon (In re Grignon/Hendrix (D. Or. 2010)); Nevada (In re Okosisi (Bankr. D. Nev. 2011))
The following states MOST LIKELY allow Chapter 20 second mortgage strips:
Arkansas, Iowa, Minnesota, Missouri, Nebraska (Fisette v. Zeller (8th Cir. BAP 2011)); Northern California (In re Tran (Bankr. N.D. Cal. 2010)); Western Washington (In re Blenheim (Bankr. W.D. Wash. 2011)); New York (In re Wapshare (Bankr. S.D.N.Y. 2013)) (In re Wong (Bankr. E.D.N.Y. 2011))
Southern California (In re Victorio (Bankr. S.D. Cal. 2011)); Northern Illinois (In re Fenn (Bankr. N.D. Ill. 2010)); Central Illinois (In re Jarvis (Bankr. C.D. Ill. 2008))
Call an experienced bankruptcy firm in your area and ask about Chapter 20. If the attorney doesn't immediately know the answer, I suggest calling a different attorney who does.