The Short Answer
If your HELOC balance exceeds your home's current value — and your first mortgage alone already equals or surpasses what the home is worth — you may have a real option to strip off that HELOC through Chapter 13 bankruptcy. This process, called lien stripping, treats the HELOC as an unsecured debt and can eliminate it entirely once you complete your plan and receive a discharge. Doing nothing, attempting a short sale, or letting the creditor write off the debt all carry serious financial and legal consequences. Speaking with a bankruptcy attorney is the fastest way to know which option actually protects you.
A few years ago when your home had equity, you obtained a Home Equity Line of Credit or HELOC to consolidate your debt and payoff credit cards, medical bills, personal loans, etc. It seemed like a great idea because you could eliminate all of your revolving debt and make only two payments each month…your first mortgage and your HELOC payment. This approach also provided a way to lower your monthly payment, since the interest rate on the HELOC was less than what you were paying on credit cards. And we all thought at that time your home would appreciate in value!
That was circa 2008 and here you are in today. You are lucky if your home is worth what you owe on the first mortgage, there’s no way will it will cover the HELOC. So your HELOC has you locked! What are your options?
Do absolutely nothing – You can see what is the HELOC creditor is going to do.
The HELOC creditor could foreclose on your home but probably not, since they would receive little if anything from the sale. However, your credit will be negatively impacted because of late, slow or no payments on the HELOC. The impact on your credit will make it difficult for you to obtain other credit for another car or other needs.
The HELOC creditor may actually decide to foreclose on the property. They know they will receive little or nothing from the foreclosure, but they can write-off the bad loan from their books making the company more financially sound.
The HELOC creditor may write-off the debt on the loan and send a 1099C to you and the Internal Revenue Service. It appears that this voluntary non-payment is excluded from the Mortgage Forgiveness Debt Relief Act of 2007. At this point you will be responsible for taxes on the forgiven debt. You should also remember that the creditor writing off the debt does not eliminate the lien by deed of trust on your home. If you try to sell the house in the future, you must still deal with the HELOC creditor before you can convey the deed to another person.
Sell the home – You would sell the home, but you can’t get enough to pay the first mortgage and the HELOC.
You’ve talked to the HELOC creditor about a short-sale, and they want you to come to the closing table with at least some money to pay them.
Since you don’t have the money at closing, they have agreed to release the lien for you to sell the house, but they want you to sign an unsecured loan on at least a portion of the debt you owe them. That is an option, but do you really want to pay for a house you do not own? If you default on this unsecured loan in the future, they can actually sue you for the unpaid debt.
Chapter 13 bankruptcy – You can file a Chapter 13 bankruptcy to resolve the HELOC and any other outstanding debt.
The key is that your first mortgage must be greater than the value of your home.
You will be required to file a lawsuit or adversary proceeding in bankruptcy against the HELOC creditor.
You must complete your bankruptcy and receive a discharge.
This approach will allow you to retain your home and make it a more valuable asset, since you will no longer be saddled with the HELOC.
We you speak with your accountant or a bankruptcy attorney to determine what option is best for you.
Key Takeaways
- If your home's value is less than what you owe on your first mortgage, Chapter 13 bankruptcy may allow you to strip the HELOC lien entirely and treat it as unsecured debt.
- Doing nothing is not a neutral choice — the HELOC creditor can foreclose even when they'd receive little or nothing, simply to clean the bad loan off their books.
- A 1099-C from a HELOC write-off means the IRS treats the forgiven amount as taxable income, which can create a significant unexpected tax bill.
- Signing an unsecured loan at a short-sale closing to satisfy a HELOC means you're still on the hook for a debt on a home you no longer own — and the creditor can sue you if you default.
- Lien stripping in Chapter 13 requires filing an adversary proceeding against the HELOC creditor and completing the full bankruptcy plan to receive a discharge before the lien is eliminated.
- A HELOC creditor's written-off debt does not automatically release the deed of trust lien — that lien must be formally addressed before you can sell or transfer your home.
Attorney Insight
The mistake I see most often with underwater HELOCs is homeowners assuming that because the HELOC creditor "probably won't foreclose," they're safe to just stop paying and wait it out. That calculation ignores the 1099-C risk — the IRS doesn't care that you got nothing out of the deal; forgiven debt is income to them. What surprises clients even more is learning that a written-off HELOC still leaves an active deed of trust lien on their property, which will surface the moment they try to sell. Chapter 13 lien stripping is one of the most powerful tools we have in NC, but it only works when the numbers are right — specifically, when your first mortgage balance already equals or exceeds the home's fair market value at the time you file.
