When Can a Debtor Remove or Strip a Second Lien from Their Home?
In many cases a debtor will have more than one mortgage lien on their real property. These second mortgages come in the form of second deed-of-trusts, equity lines, and home improvement loans. Oftentimes, the first mortgage will exceed the total value of the home. For example, the debtor may have a first mortgage of $125,000.00 against a house that is only worth $100,000.00. Then, on top of the first mortgage they also have a second mortgage of $50,000.00. In order for the debtor to keep the property he must continue paying secured debts like mortgages; or the debtor can surrender the property back to the creditor and discharge the debt.
The question becomes whether the second mortgage is actually a secured debt. If the second mortgage is a secured debt, the debtor must continue paying for it in order to keep the property. A plain reading of the bankruptcy code would suggest that the second mortgage is unsecured, thus allowing it to be discharged and the lien removed from the property. The bankruptcy code reads, an “allowed claim of a creditor secured by a lien on property . . . is a secured claim to the extent of the value of such creditor’s interest in . . . such property,” and “an unsecured claim to the extent that the value of such creditor’s interest . . . is less than the amount of such allowed claim.” Bank of America, N.A. v. Caulkett.
It is clear that Congress intended that secured claim is only secured up to the value of the property being secured. In the case of an underwater second mortgage, the bank’s claim attaches to zero equity – and therefore is not secured. This would be good news for debtors that have underwater second mortgages; except for the fact the U.S. Supreme Court rejected Congress’s clear intent and plain meaning of the statute in Bank of America, N.A. v. Caulkett, 575 U.S. ___ (2015).
In the Caulkett decision, the High Court acknowledged that the plain reading of the code would allow the debtor to strip the underwater second mortgage. The Court went on to state that in a prior decision, Dewsnup v. Timm, 502 U.S. 410 (1992), they had already defined “the term ‘secured claim’ in 506(d) to mean a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim.” Based on the Dewsnup decision, the Supreme Court ruled that “a debtor in a Chapter 7 bankruptcy proceeding may not void a junior mortgage lien under 506(d) when the debt owed on a senior mortgage lien exceeds the current value of the collateral.”
Prior to the Caulkett decision, the Bankruptcy Courts in the Eastern District of Virginia had not been allowing lien strips in Chapter 7 bankruptcies, now that the U.S. Supreme Court has ruled, all jurisdictions should be following the same rule.
If you have a second mortgage that does not attach to equity, then you may want to consider filing a Chapter 13 bankruptcy.