The treatment of secured debts in a Chapter 13 is relatively straight forward. By its nature, a Chapter 13 will generally allow you to reorganize your debts, especially secured debts, under the protection of the bankruptcy stay. This will allow you, in the case of your home, to pay back your mortgage arrearages over the life of your Chapter 13 plan or, in the case of a car, allow you, under the correct circumstances, to recalculate the outstanding balance on the loan and/or the interest rate you must pay. One thing that is also very common in a bankruptcy setting is the presence of a subordinate mortgage debt to a debtor's first or primary mortgage. Often referred to as second or even third mortgages, a Chapter 13 can provide a real benefit to someone with such a mortgage obligation.
A Chapter 13 provides a debtor with a powerful tool to reorganize debts under very specific circumstances. That tool is often referred to as a lien strip. This is something that under prevailing bankruptcy law is not available to someone in a Chapter 7. Pursuant to 11 U.S.C. §§ 506(a) and 1322(b)(2) a debtor can not only discharge a promise to pay a subordinate home loan by reclassifying it as an unsecured debt, but can also remove the subordinate position lien from the property. The important requirement is that the value of the home must be less than the balance of the primary mortgage obligation on the date of filing. If the value of the home is no longer greater than the balance of the first mortgage, than the subordinate mortgage is considered unsecured.
This lien strip can be accomplished a couple of ways depending on how your jurisdiction views the proposed Chapter 13 Plan. In Maryland, your intent to reclassify the debt as unsecured must be noted in your proposed plan. In addition, prior to confirmation, you will need to file a motion to value the property and strip the lien. The motion must be properly noticed out and mailed to the correct parties. In general, this means you will need to mail a copy of the motion, notice, and supporting evidence to your lender, the mortgage note holder, the mortgage servicer, the deed of trust trustee, the individual who filed a proof of claim on behalf of the creditor, and the CEO of any bank with an interest in the note. If no response is filed to your motion within the allotted time, the Court will generally sign an order avoiding the lien, assuming your evidence supports your request.
What evidence do you need? At a minimum you will need to have a professional appraisal completed on your home. This is generally going to cost somewhere in the neighborhood of $300 - $500. The appraisal is your best evidence of fair market value of the home. In addition, you will most likely want to submit copies of the deeds of trust to support your claim that one of the mortgages is subordinate to the other. Finally, you may also attach market value estimates from places like Zillow.com or one of the major banks like PNC or Bank of America; both generally have home value calculator tools.
Once the Court grants the motion you will need to successfully complete your plan payments and receive your Chapter 13 discharge. If you fail to complete your plan as confirmed or fail to obtain your Chapter 13 discharge the loan and lien are automatically reinstated. Once you have successfully completed the plan you may have to request a judgment order from the Court to finalize the lien strip process.
In my next post I will discuss the mechanics of cram downs in a Chapter 13.