Avoiding a Second Mortgage in Bankruptcy
As a consequence of the decline in the real estate market many clients are asking about the status of their second mortgages. It is not understood by most lay people under what circumstances a second mortgage can be “avoided” or stripped from an underwater home.
The most common second mortgage scenario in my practice for many years was the Countrywide Mortgage “eighty – twenty loan”. As it turns out, Countrywide had a standard practice of providing one hundred percent financing and breaking the financing up into two loans. Oddly enough, in many instances I investigated, the first mortgage was recorded promptly while the second mortgage for the “twenty percent” was recorded months later.
No Equity These Days
Most of these “twenty” mortgages are no longer hitting any equity. Neither are a great many second mortgages that were taken out over the last several years. What can be done about it? Clearly the Code and case law tells us that a secured parties’ rights cannot be altered in Chapter 7, but what about Chapter 13? As a general rule the rights of secured parties, like mortgage lenders, cannot be modified in a Chapter 13 Plan. (11 U.S.C. sec. 1322(b)).
However, if valuation of the property becomes an issue in a secured claim (SEE 11 U.S.C. §506(a)) and an appraisal determines that a junior mortgage holder’s claim is wholly unsecured, then the mortgage lender is not in any respect a “holder of a claim secured by the debtor’s residence” under §1322(b), the so called “anti modification clause”. As a result, the junior mortgage holder simply has an unsecured claim and the anti-modification clause does not apply. Most importantly if any part of the mortgagee’s claim is secured the entire claim, both secured and unsecured parts, cannot be modified.
In order to successfully strip a completely unsecured lien in a Chapter 13 case, the debtor must be entitled to a discharge and must in fact receive a discharge. In addition, the debtor must ask the court to remove the lien from the property by filing a lawsuit known as an adversary proceeding. It is also clear that a debtor that has received a prior Chapter 7 discharge cannot file a Chapter 13 case merely to strip off a lien. (The so-called Chapter 20 case.)
New Legislation in the Works?
The U.S. Congress has long debated legislation that would grant Bankruptcy Judges increased authority to reduce first mortgage liens to the value of the property. This authority will require legislation. Allowing the Bankruptcy Court to adjust secured debt according to current valuations may go a long way to solving some of the existing problems in the housing market.
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