Lien Stripping in Bankruptcy is Court Ordered Mortgage Modification
One of the advantages to filing chapter 13 bankruptcy is the ability to strip an “under secured” junior mortgage lien. When a homeowner owes more on their first mortgage than their home is worth, Chapter 13 allows junior mortgages to be removed or “stripped” which has the effect of reducing housing costs. In essence, a lien strip is a court ordered mortgage modification, which brings a property’s debt in line with its current market value. The practice is especially valuable in states like Florida that have been hardest hit by the housing crisis.
Must a debtor be eligible for discharge in order to strip in mortgage lien under Chapter 13 bankruptcy?
Under normal circumstances, the debtor seeking to have a mortgage lien stripped is also eligible for a discharge in the chapter 13 case. However, is the debtor’s right to strip a junior lien contingent on eligibility for discharge? A Florida court has recently answered the question in the negative, ruling that a lien can be stripped through chapter 13 bankruptcy even when a prior chapter 7 filing prevents the debtor from receiving a discharge in the subsequent chapter 13 case.
In Re Dang
In Re Dang involved a Florida resident who filed for chapter 7 bankruptcy and very soon after receiving her discharge, filed a chapter 13 bankruptcy to strip a mortgage lien from her primary residence. The Chapter 13 trustee objected to confirmation of the plan, arguing that the debtor’s prior chapter 7 discharge precluded her from stripping the lien in the chapter 13 case. In ruling for the debtor, The Bankruptcy Court for the Middle District of Florida joined a growing trend in district courts towards allowing lien stripping in cases where a debtor is not eligible to receive a chapter 13 discharge. The practice of filing chapter 7 bankruptcy to extinguish personal liability on one’s debts and then subsequently filing chapter 13 bankruptcy to remove a mortgage lien is known as Chapter 20 bankruptcy. Although courts throughout the country are split on the practice, this is the second time in a little over a month that the Middle District of Florida has approved a chapter 20 strategy (In Re Scantling).
How does the case close without a discharge?
Under Section 349 of the bankruptcy code, any lien voided under section 506(d) shall be reinstated if the case is dismissed. Without the benefit of a discharge, how do debtors avoid dismissal and reinstatement of the lien? Courts have ruled that as long as the debtor in a chapter 20 case completes their plan payments, the case will be closed rather than dismissed and their lien will remain removed.