Mortgages in bankruptcy can be discharged, but the lien remains absent specific circumstances
When considering bankruptcy, many people ask to leave their mortgage out of the bankruptcy. This is not possible; you must include all your debts. However, a mortgage is treated differently than your credit cards or personal loans, it is secured against property.
Most individuals cannot afford to buy a home outright. They need help of buying a property with a mortgage. This mortgage is a lien against the property. The lien allows the mortgage company to take back the property if the terms of the loan are not followed. It also requires that the mortgage loan be paid back in full if the property is ever sold or transferred.
A second mortgage is usually referring to a junior debt that is secured against a property. This could be a loan that was obtained at the time of purchase or years later. A second mortgage could be a home equity loan with revolving terms, often referred to as HELOC, or a traditional 15 or 30 year loan.
There is a common misconception that second mortgages retain limited rights. Second mortgages have basically all the same rights as a first mortgage, only the junior mortgage is second in line in interest on a property. Often a second mortgage will not proceed with a foreclosure due to the fact they must either foreclose subject to the first mortgage or pay the first mortgage off. But, if there is enough equity in a property, it can make perfect financial sense for a second mortgage to foreclosure.
Our office has even seen second mortgages foreclose when there is minimal equity after a first mortgage. This may occur because a creditor wants to limit the debtor’s ability to incur anymore debt through late payments, fees, interests, etc.
Many people use a Chapter 7 as a tool to stop a foreclosure or keep a mortgage company from coming after them. If you cannot afford your house, and the property is worth less than what is owed on the property (or there is only de minimus amounts of equity), then a Chapter 7 can be a great tool. Filing Chapter 7 can ensure that debtors are not responsible for any deficiencies that remain after a foreclosure (basically any balance of the loan(s) that a foreclosure sale does not satisfy). Additionally, if the bankruptcy happens prior to a foreclosure being completed, it keeps a debtor’s credit cleaner; a foreclosure would not appear on a debtor’s credit because he/she would not longer have any obligation to pay on the debt at the time the foreclosure happened.
A Chapter 7 only takes care of the in personum obligation of a debtor. Basically, a discharge in a Chapter 7 covers the Debtor’s obligation to pay on their mortgage. A mortgage company cannot force a debtor to pay after a Chapter 7; additionally, if there is a foreclosure, a mortgage company cannot try to collect on any deficiency from the debt. However, in a Chapter 7, the lien remains on the property – this applies to all mortgages. This means that a mortgage company can still foreclose on the property to retake the collateral. A foreclosure against only the property , also referred to as an in rem proceeding.
If you reaffirm a mortgage during your bankruptcy, then all obligations for the mortgage return. The mortgage company can come after the debtor for any unsatisfied obligation.
Mortgage Liens Remain After Chapter 7
Many individuals come to see an attorney years after their bankruptcy. They are confused about why the second mortgage company is trying to foreclose. They say that the their bankruptcy included the second mortgage. Sometimes, the debtor even continued to pay the first mortgage. Usually this confusion comes in because their attorney did not explain the difference in the personal obligation and the lien.
The same terms of the all mortgages remain with the lien after the Chapter 7 bankruptcy. Your mortgage lender may be willing to do a modification to lower your interest and payments, but they are not required. If you do not comply with the terms of the debt, the mortgage company can foreclose. On a rare occasion, a second mortgage may reduce the balance or forgive a debt after a bankruptcy. This is usually done, if they believe it is not in their best interest to continue having the outstanding liability or that a tax reduction for writing off the loan is in their best interest.
In a Chapter 13, you must submit a plan to the court explaining your intent with the property. This plan will tell the court if you plan to keep or give up a property. It also likely will tell the court how you plan to repay any arrerages on the property.
A Chapter 13 can be a great tool to help a debtor catch-up on a first and/or second mortgage. A Chapter 13 would allow a debtor to pay back arrearages over the course of 3 to 5 years. While paying back the arrearage, you must also continue to make your regular payments to the mortgage company.
2nd Mortgage Strip off
One very special reason some people file Chapter 13 is to strip off the second mortgage. This process can only occur in a limited number of circumstances. Basically, a second (or even a third or fourth) mortgage can be removed from a debtor’s property if it is wholly unsecured. This means that the value of the senior mortgage is greater than the fair market value of the property. If the property is worth even a penny more than the balance of the first mortgage, then it is considered that the second mortgage has something to attach to and cannot be removed through a Chapter 13 strip off.
In a strip off, the debtor must file a separate lawsuit within his/her bankruptcy. The bankruptcy court must determine the property value is less that the mortgage(s) senior to the mortgage being removed. If the court determines that to be appropriate then the court issues an order that the lien must be treated as unsecured for the rest of the bankruptcy and after the Chapter 13 plan is complete, the liens of the junior mortgage(s) are removed.
With housing prices on the rise and increasing back to pre-2007 levels, this process is getting less common, but it still will be completed from time to time.
Court Orders are Required to Remove any Lien
The rule of thumb at the end of the day is that bankruptcy usually only takes care of personal liabilities. Liens are a special situation; no lien or mortgage can be removed from property unless there is a court order from a judge, the debt is completely satisfied, or the creditor agrees to voluntarily release the debt. Any creditor with a mortgage lien can foreclose on a property as long as the lien is valid.
Attorney Ashley F. Morgan is a Virginia licensed attorney. She has been helping clients stop foreclosures using bankruptcy and non-bankruptcy options. Ashley has successfully helped many debtors strip off second mortgages from their properties. She has also helped numerous individuals catch-up on their mortgages and save their homes through a Chapter 13 plan.