Eliminating a Second Mortgage

In the past eliminating a "junior" or second mortgage in a bankruptcy has simply not been possible. Second mortgages have historically been considered by bankruptcy court to be "secured" and secured debts receive much different treatment than unsecured debts in bankruptcy court.. until recently.

As you may already know, the difference between a secured and unsecured debt is "collateral".. a word we have all heard before. Falling behind on vehicle or mortgage payments can result in the finance company acting on their "collateral" interest and repossessing and/or foreclosing on a property.

Unsecured debts [such as credit cards and personal loans] have no collateral attachments so it's much easier (in most cases) to eliminate those type of debts in a bankruptcy filing. Secured debts filed in bankruptcy [such vehicle loans, mortgages, time shares] typically require a repayment plan under Chapter 13 which is designed for income or wage earners.

However, some bankruptcy courts in growing instances have in fact adjudicated the elimination of a second mortgage in a Chapter 7 bankruptcy action.

The rationale behind eliminating a second mortgage is that the second mortgage, although originated with proper collateral, no longer has any equity to secure the loan. If the home value drops and the loan amount becomes greater than the home's market value, the second mortgage is deemed unsecured and is discharged. That second mortgage gets treated just like if it were an unsecured credit card.

Eliminating a second mortgage in bankruptcy court is highly controversial among differing districts as there there is still no agreement between them to wholly eliminate second mortgages.

Most bankruptcy courts in the nation are opposed to the idea, but there is an increasing support by bankruptcy courts to eliminate at least part of a second mortgage in a chapter 13 repayment plan. Chapter 13 bankruptcy allows some secured and unsecured debts to be reduced at least in part in a 3 to 5 year bankruptcy court supervised repayment plan.

The functionality of chapter 13 bankruptcy allows debtors to utilize the chapter 13 repayment plan to achieve a lower monthly payment on vehicle or second mortgage payments. Bankruptcy courts typically allow unsecured debts to paid at least in part in a chapter 13 repayment plan as long as the debtor can afford the future payments.

The process of eliminating or reducing a second mortgage in bankruptcy is commonly known as "Lien Stripping". First mortgages have been decidedly untouchable by Congress after legislative attempts failed to allow the "cram-down" or principle balance reduction of first mortgages.