Redwood City Bankrutpcy: Regarding the Lien Strip

To a homeowner filing for Chapter 13, the opportunity to lien strip a junior mortgage on a home presents a unique (and potentially lucrative) opportunity.
First, assume the typical situation where a home is owned and occupied by the debtor;

Next, determine whether a second (or any lien junior to the first mortgage) exists which is wholly unsecured. This means that if the home is worth $300,000 and what is owed on the first mortgage is $350,000, then the lien-holder of the second mortgage has no security. If a foreclosure were to occur, this junior lien-holder would get nothing – every dime that the home fetches when sold, up to $350,000, goes to the lender on first mortgage. This is true regardless of the size of the second mortgage. Here let’s say it is for $200,000. It is only when the home sells for $350,001 that the second lien-holder would get something. This means he has a secured interest. Here, that security would be one dollar’s worth, but even one dollar is enough to prevent a lien-strip: the junior lien must be 100% unsecured.
Finally, a Chapter 13 appropriate motion must be filed before the court. The affected lender can oppose the motion, but only if facts detailed above are correct,  then the lender cannot stop the lien-strip. The best defense a lender can present is that the home is partly secured, by saying, for instance, that the home’s appraisal of $300,000 is wrong and, in fact, the house is worth $356,000 (thereby creating a $6000 security, even though its investment may be $200,000). Once the court deems it unsecured, the stripped lien is then classified as unsecured and treated in the payment plan akin to credit cards or medical bills.

In sum, the lien-strip provides a homeowner-debtor the opportunity to save hundreds of thousands of dollars. The example provided above is very common because when housing values soared, lenders lent; and now that housing values have fallen, second and third mortgages or Home Equity Lines of Credit have become unsecured. Keep in mind, though, that to fully discharge the lien, the debtor must stay current on their Chapter 13 plan. Also, a lien strip is not available to Chapter 7 debtors. For a similar discussion of modifying liens on automobiles, go to The Cram Down.

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