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Newburgh Area Lawyers Discuss Avoiding Second and Third Mortgages

In a Chapter 13 case there are circumstances where a second (or third) mortgage encumbering real estate, including your residence, can be Stripped Off (ie., gotten rid of), or voided. If you have a second (or third) mortgage on your residence, and the value of your residence is less than the balance due on the first mortgage, you can Strip Off the second (or third) mortgage and treat it as an unsecured claim. However, you can only do a second (or third) mortgage Strip Off if (1) there is not one single dollar of equity in the house for the mortgage to attach to, and (2) you stay in your Chapter 13 until its completion and receive a Chapter 13 Discharge.

Examples of Strip Off applied to a second or third mortgage

Three examples will illustrate how Strip Off can be applied to a residence valued at $300,000.00 and subject to a $50,000.00 second mortgage (or home equity loan) and a $30,000.00 third mortgage (or home equity loan).

Example # 1

If the first mortgage has a balance due of $240,000.00, then neither the $50,000.00 second mortgage nor the $30,000.00 third mortgage can be Stripped Off, because there is $60,000.00 worth of equity (ie., $300,000.00 value minus $240,000.00 first mortgage equals $60,000.00 equity) for the second mortgage to attach to, and $10,000.00 worth of equity (ie., $300,000.00 value minus $240,000.00 first mortgage minus $50,000.00 second mortgage equals $10,000.00 equity) for the third mortgage to attach to.

Example # 2

However, if the balance due on the first mortgage is $310,000.00 the entire $50,000.00 second mortgage and entire $30,000.00 third mortgage can be Stripped Off, as there is no equity in the residence (valued at $300,000.00) for either mortgage to attach to.

Example # 3

However, if the balance due on the first mortgage is $270,000.00, the $50,000.00 second mortgage cannot be Stripped Off, because there is equity of $30,000.00 ($300,000.00 value minus the $270,000.00 first mortgage equals $30,000.00 equity) for it to attach to, but the entire $30,000.00 third mortgage can be Stripped Off because there is no equity for it to attach to, since the first and second mortgages total $320,000.00 and the house is valued at only $300,000.00.

If a second or third mortgage can be Stripped Off, it can dramatically improve a Debtor’s chances of successfully completing a Chapter 13 Plan. Since the debtor no longer has to make regular monthly payments to the holder(s) of the Stripped Off mortgage(s), additional income is “freed up” that can be applied toward your monthly payment to your Chapter 13 Trustee. In this instance the principal balances owed to the holders of the Stripped Off mortgage(s) will be treated as any other unsecured debt and repaid thru the Plan payments made to your Chapter 13 Trustee, usually resulting in the mortgage holder receiving only a fraction of the amount actually due, with the rest being Discharged in bankruptcy.

It must be noted that there is considerable danger awaiting a debtor who Strips Off a second mortgage in Chapter 13 but fails to see his Chapter 13 case through to a Discharge. If a Chapter 13 case is dismissed, the Bankruptcy Court order Stripping Off the second (or third) mortgage no longer has any force or effect. In addition, the U.S. Supreme Court has made it clear that mortgages cannot be Stripped Off in a Chapter 7 bankruptcy. Accordingly, if a debtor’s Chapter 13 case is either dismissed or converted to Chapter 7, the Chapter 13 order Stripping Off the mortgage(s) no longer has any force or effect. The obvious resulting problem is that since the debtor has not been making his regular monthly payments to the holder of the Stripped Off mortgage(s) during the Chapter 13 case, the debtor is very far behind on his monthly mortgage payment obligation once the Stripped Off mortgage comes back to life. The moral of this story is that if you Strip Off a mortgage in Chapter 13, you had better be sure that you get your Chapter 13 Discharge.