The Short Answer
If you're underwater on your home and have a second mortgage or HELOC, Chapter 13 bankruptcy may allow you to "strip" that junior lien entirely — treating it as unsecured debt and eliminating it upon discharge. This works when your home's current fair market value is less than what you owe on the first mortgage, leaving the second mortgage with no equity to attach to. The stripped lien is discharged at the end of your 3–5 year Chapter 13 plan, so you exit bankruptcy owing only your first mortgage. It's one of the most powerful — and least talked-about — tools available to homeowners in financial distress.
With the decline in the housing market many people find they are “upside down” or “under water” on their home. In other words, do you owe more for the house than what it is worth? If that is your situation and you have two or more mortgages, you may find that Chapter 13 bankruptcy is an option you have never considered.
Let’s look at an example where Chapter 13 bankruptcy may help you:
You have a home with a fair market value of $150,000. Three years ago the house was worth $200,000.
You have a first mortgage on the home for $160,000 and a second mortgage or HELOC for $40,000. In other words, you owe more on the first mortgage than the house is worth.
You can easily make the first mortgage but the second mortgage is more than you can afford.
You know it will be several years before the house is valued at $200,000 again.
As a result, you are stuck making two or more mortgage payments on the home and it isn’t worth it.
You are contemplating a short-sale which leaves you without a home and a “ding” on your credit or you are considering walking away from the home and letting the mortgage company foreclose.
If this is your situation, you should consider a Chapter 13 bankruptcy. With the Chapter 13 bankruptcy, you may be able to “strip” or eliminate the second lien/mortgage. Within the bankruptcy, you are able to eliminate the lien on the house as long as you complete the Chapter 13 bankruptcy within the three to five years required by the bankruptcy laws. The number of years you must be in the bankruptcy will depend on your specific situation. Let’s use the example above to see how it might work for you.
Your first mortgage is $1,100 per month.
You have $10,000 in credit card debt, a $2,000 personal loan and $750 in medical bills.
You owe $40,000 on the second mortgage that may be eliminated in your Chapter 13 bankruptcy.
You meet with the bankruptcy attorney and determine that you qualify for a Chapter 13 bankruptcy and it appears you are eligible to strip the second lien in the bankruptcy.
Your Chapter 13 plan payments are estimated at $1,300 – $1,500 including your first mortgage and other debts including the second mortgage.
Once the bankruptcy is filed, your attorney will file a lawsuit or adversary proceeding against the mortgage company or they may be able to simply file a motion to strip the lien. Each bankruptcy court has their own requirements, so you should speak with your bankruptcy attorney to determine what must be completed in your case.
Once this process (either adversary proceeding or motion) is completed, the bankruptcy court will issue a judgment or order that voids the second lien on the house as long as you complete and receive a discharge in your Chapter 13 bankruptcy.
Once the bankruptcy is discharged and completed, three to five years after you file, you will resume payments on your first mortgage but the second mortgage and the other debts listed in your bankruptcy are eliminated and you will not be responsible for making payments on these debts in the future.
As a result, if you decide to sell your house in the future, you will only be required to pay off the first mortgage. The second mortgage is no longer a factor.
This is obviously a simplified approach, so you should seek the advice of a bankruptcy attorney to see if stripping your second or third mortgage or HELOC is an option for you. You are thinking this must be too good to be true otherwise someone would have mentioned this to you before! It really is fairly simple. This is just one way a Chapter 13 bankruptcy may assist you in keeping your home when you are upside down or under water.
Key Takeaways
- Lien stripping in Chapter 13 is only available when your home's value is less than the balance owed on your first mortgage, leaving the second mortgage or HELOC entirely unsecured.
- The stripped lien is not permanently removed until you complete your Chapter 13 plan and receive a discharge — you must finish what you start.
- Depending on your bankruptcy court, your attorney will either file an adversary proceeding or a motion to strip the lien, and the requirements differ between NC's Middle and Western Districts.
- After discharge, you resume payments only on your first mortgage; the second mortgage and other listed debts are eliminated and you are no longer legally responsible for them.
- If you sell the home after discharge, only the first mortgage must be paid off — the stripped second lien no longer encumbers the property.
- A short sale or foreclosure may seem like your only options when you're underwater, but Chapter 13 lien stripping lets you keep your home and shed the debt that's making it unaffordable.
Attorney Insight
The mistake I see most often is homeowners walking into a short sale or just mailing back the keys when lien stripping was sitting right there as an option. In nearly 30 years of practice, I've had clients save their homes and shed $40,000–$80,000 in second mortgage debt through this process — debt they assumed was as permanent as the first mortgage. The procedure differs between NC's Middle and Western Districts, so the first question I ask isn't just "are you eligible?" but "which court are we in, and what does that trustee require?" Getting that wrong at the outset can cost you months and jeopardize the strip entirely.
