Stripping Revisted

Petition for Bankruptcy paperwork being filled out.

While it is probably intuitive that Bankruptcy allows for the elimination of liens on property, it is unclear to most the difference between perfected liens creating security in property and judgment liens which are attached to property after a lawsuit.

The former category of lien, secured liens (which homes and cars fall into) can only be eliminated in conjunction with surrender of the collateral itself; such as voluntarily surrendering the vehicle, or deeding the house back to the creditor. When this is done, the creditor’s debt then becomes unsecured, the same as credit card debt, which can be wiped away by a Bankruptcy discharge.

The latter category, a judgment lien, garnishment, deficiency judgment, etc. are dischargeable as they are not tied to any particular property, but instead the debtor individually. When it comes to mortgages the general rule is that while the obligation to pay a creditor Mortgagee (the bank or person who holds the mortgage) is discharged in Bankruptcy, the mortgage (the creditor’s right to have property sold) remained against the property. In other words, the creditor could not collect from the debtor, but could still try to collect from the sale of the property by foreclosing afterward.

This still remains the case for (1st) first mortgages, but the bankruptcy code carved out an exception for junior mortgages in 11 U.S.C Sections 506(a) and 506(d). These second mortgages could be stripped off the property at the discharge of the debtor from Bankruptcy. Prior to May of this year, this remedy was deemed only available in Chapter 13, which is the longer, more expensive Chapter of Bankruptcy for the consumer debtor. Chapter 13 involves a debtor repayment commitment of 3-5 years.

In May, 2012, the 11th Circuit handed down a ruling in the case of McNeal. GMAC 2012 WL 1649853, clarifying and establishing that in its interpretation of the Bankruptcy code the law allows a (2nd) second mortgage to be stripped in both Chapter 7 and Chapter 13, debunking the assumption which for years most Bankruptcy attorneys and some Bankruptcy Judges in the circuit had been operating by.

This is a significant ruling in that many homeowners would be able to better survive if they did not have those higher interest, revolving credit-type mortgages plaguing them each month. Even more significant is that with the second mortgage gone, the negative equity is diminished, thus, bringing the home closer to its debt encumbrance, enabling it to become qualified for modifications, refinancing, or even sale.

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