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A Chapter 13 bankruptcy will allow you to get rid of underwater second mortgages or equity lines of credit. If the value of your house has dropped to below what is owed on the 1st mortgage, then any other mortgages or liens are completely valueless. Section 506(a) provides that a mortgage holder is only secured up to the value of collateral securing the mortgage.
Example:
- Purchased house in 2006 for $700,000
- 1st Mortgage $500,000; 2nd Mortgage $200,000
- Value of the house decreased since 2006 to $455,000
- 2nd Mortgage of $200,000 is now completely unsecured, given the that the value of the house is less than what is owed on the 1st mortgage
- 2nd Mortgage is underwater and has no equity or value
- Chapter 13 allows you to avoid/strip off mortgages that have no value
To value of lien at zero and avoid the lien an adversary proceeding (lawsuit) or motion must be filed with the Court seeking have the Bankruptcy Court rule the value of your house is less than what is owed on the 1st mortgage. A notation is added to the Chapter 13 plan that it is your intent to value and avoid the second mortgage or equity line of credit. Most jurisdictions and Chapter 13 Trustee’s offices require that this issue be resolved before their office will recommend confirmation of the Chapter 13 plan of reorganization.
The holder of the second mortgage or equity line of credit can oppose the motion to value and avoid their lien. They must successfully argue that the value of your house is more than what is owed on the 1st mortgage. An evidentiary hearing is held if a motion is filed and a small trial is held if an adversary proceeding is filed. The Bankruptcy Court will take the testimony of appraisers and/or you to determine what the value of your house was at the time the case was filed.
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