As a general rule of thumb liens float through bankruptcy, but there are some exceptions that are applicable in reorganization cases (Chapter 11, 12, and 13). In Chapter 13 bankruptcy, what is referred to as “lien stripping” is the process by which a person can wipe out any junior liens attached to their real estate. A “junior lien” is usually a second or third home mortgage. For more information about whether you can benefit from lien stripping, be sure to contact one of our Albuquerque bankruptcy attorneys.
The ability to remove unsecured liens in a Chapter 13 comes from several sections of the bankruptcy code. Specifically, 11 U.S.C. § 1322(b)(2) allows a debtor to “modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence[.]” 11 U.S.C. § 506(a)(1) then provides the definition for a secured and unsecured claim. Finally, 11 U.S.C. § 506(d) provides “To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.” These provisions thus allow a debtor to remove wholly unsecured liens from real estate. Although some individuals have attempted to strip liens in a Chapter 7 bankruptcy, the Supreme Court in Dewsnup v. Timm, 502 U.S. at 418, 112 S. Ct. at 778 (1991) , said that lien stripping is not applicable to Chapter 7 debtors.
Partially secured liens on a principal residence cannot be stripped either because they are afforded protection by 11 U.S.C. § 1322(b)(2) pertaining to secured claims. A partially secured lienholder technically has secured claim (even though only a portion of it may be secured) pursuant to 11 U.S.C. § 506(a)(1) and is thus protected from modification of their rights.
The lien stripping tactic can allow you to abolish any liens on your property which are wholly unsecured. Any time there is a lien attached to your home, the priority of that lien compared other liens on the property will typically be determined by the time at which the lien was recorded. Generally, the sooner the lien was recorded, the more priority it will have over liens that were recorded later. If your home is foreclosed on then, priority will be given to your very first mortgage lender, and the money from the sale of your home will go to the first lender before subsequent lenders could recover any of the proceeds.
In numerous cases, a subsequent mortgage lender won’t receive anything at all if the borrower owed more than the market value of the home, as there won’t be anything left over after the priority mortgage lender is paid. If this happens and the second or third lender does not (or would not) get anything, the second mortgage will be dubbed “wholly unsecured,” and might be stripped in Chapter 13 bankruptcy.
For example, imagine that you won a home that is worth $200,000, and you still owe $300,000 on your first mortgage. Here, you will likely be able to have any liens stripped that are “junior” to the first mortgage. So, if you had taken out a second home mortgage for $100,000, you would be able to have that junior mortgage stripped in Chapter 13 bankruptcy because if your home were foreclosed on, that second lender would recover nothing from the proceeds of the home’s sale.
Any stripped liens will get treated the same as your other unsecured debts like medical bills and credit cards. Generally, these debts get a very small portion of what was originally owed, or simply get nothing and are discharged by the bankruptcy court once the bankruptcy proceedings conclude. After a lien is discharged, the lender in charge of the lien must remove the lien from your property.
Lien Stripping can be tricky as it does not apply to every type of lien available. However, when a lien can be stripped, it provides additional relief for a debtor trying to improve his or her situation. I often tell clients that they’re generally hiring me to not only prepare their bankruptcy, but because I can help them maximize the benefit they get out of filing for bankruptcy; lien stripping is a perfect example of why having an experienced bankruptcy attorney matters, not only will the attorney determine if lien stripping is applicable to a particular lien, but your attorney will know how to effectuate a lien strip procedurally through your bankruptcy case. If you are considering a Chapter 13 bankruptcy, feel free to contact our office for a free consultation, where we will give you an idea of how bankruptcy can help you, and how much everything will cost.