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Stripping for Bankruptcy

One of the biggest challenges people contemplating filing for bankruptcy face is determining whether they should file a Chapter 7 or Chapter 13 (or even a Chapter 11 filing). There are many factors which are used to make this determination but one of the most important revolves around real property the Debtor owns – be it homestead or investment. This analysis will focus on the determination that a borrower with real estate will confront in choosing the proper chapter in bankruptcy.

In a Chapter 13, homeowners’ are able to “strip off” wholly unsecured liens on real property. To put this in better terms, if a homeowners’ property is fully underwater because of the first mortgage on the property, the Debtor may be able to remove the junior lien and treat it as unsecured debt in their bankruptcy. The lien would then be treated the same as a credit card, medical bill, or other unsecured consumer debts. To put this idea into numbers, let’s say you own a property with a market value of $300,000. The balance on the first mortgage is $375,000 and $45,000 on the second. You can then utilize lien stripping to void the second mortgage and render them an unsecured claim in the bankruptcy.

For those with investment property, the option of a strip down, where they reduce the mortgage to the value of the property is an available means of treating their mortgage. This option is not available if it’s the borrowers’ primary residence.

The newly unsecured claim would then receive pro rata disbursements as part of a Debtor’s monthly payments. This is especially important in a market where many Debtor’s find themselves with homes which are upside down and are struggling to make payments on their second mortgages.

Often times, the greatest issue faced with lien stripping is the actual value of the property. Debtors will often find themselves in need of an appraisal to show the Court the correct market value. If there is even a question in the Debtor’s mind (or their attorney’s) whether the market value may exceed the first mortgage balance, a homeowner should consider an appraisal prior to filing their bankruptcy.

Lien stripping was previously available in Chapter 7 filings. However, in In re Caulkett, the Supreme Court has held that these options are not available in a Chapter 7 while Chapter 13 remains a viable option in stripping off mortgages.

You should ultimately seek the advice of an experienced attorney who can assist you with determining if lien stripping, and bankruptcy, is right for you.