Getting Rid of Second Mortgages in Bankruptcy

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Getting Rid of Second Mortgages in Bankruptcy:  Let’s say you have a house with a first mortgage and a second mortgage (often referred to as a “home equity loan”).  Is there a way to get rid of that second mortgage in bankruptcy.  The answer is “Yes, well maybe.”  First off, you cannot get rid of a second mortgage unless you file a Chapter 13 bankruptcy.  “Getting rid of” a second mortgage requires stripping the lien from the property record.  That can only be done in a Chapter 13 bankrputcy and not in a Chapter 7 bankruptcy.  Secondly, the value of the house must be less than the amount owed on the first mortgage.  So, if the fair market value of the house is $100,000, and you owe $100,001 or more on the first mortgage, your second mortgage can be stripped.  But, it’s not automatic.  So, third, your attorney must file a separate lawsuit called an Adversary Proceeding.  Although it is connected to your Chapter 13 case, it is considered a stand-alone lawsuit and will be issued it’s own case number.  This requires service of summons and a petition.  It may require that you get an appraisal of the property and have the appraiser appear in court at trial to testify as to the value of the property.  So, it can be A LOT of extra work and expense.
The good news is that most times (probably 8 times out of 10), no appraisal or trial is necessary.  Early on, we evaluate our clients’ situation to determine if attempting to strip a second mortgage is a good idea.  Usually, we will recommend that a client contact a real estate agent and ask the agent to provide a CMA (“Comparative Market Analysis”).  This is a quick estimate of fair market value that an experienced real estate agent can do in only a few minutes (but be certain to return the favor to that agent in the form of a referral or other assistance).  Also, make it clear to the real estate agent that you’d like the CMA based upon the property in its current condition.  Real estate agents will often give a value based upon the assumption that you will do things to prepare the property for sale such as a fresh coat of paint or new carpet or landscaping.  But, we are interested in fair market value of the property “AS IS”.   Once you have that CMA, we’ll compare it to the amount owed on the first mortgage.  If the CMA value is 90% or less than the amount owed on the first mortgage, then you can be fairly confident that the adversary proceeding should end in your favor, and may not even require a hearing.  If the CMA value is greater than 90% of the amount owed on the first mortgage, you could still proceed, but plan on getting a full blown appraisal and be ready to pay expert witness fees to the appraiser (figure around $1,200 for the appraisal and in court testimony).  If the CMA value is greater than the amount owed on the first, you may be facing an uphill battle.
Also, don’t forget that if you do prevail in the adversary proceeding, you will still need to complete the entire Chapter 13 case and receive a discharge before the the second mortgage stripping becomes permanent.  If your bankruptcy case gets dismissed after you win your adversary proceeding, all of that hard work was for nothing.  But, in the correct circumstance, yes, you can get rid of a second mortgage in bankruptcy.  At WM Law, we’ve successfully stripped second mortgages in hundreds of bankruptcy cases over the years.
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Jeffrey L. Wagoner


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