Stripping the Lien, Cram Down or Strip Down of a 2nd Mortgage

Stripping the Lien, Cram Down or Strip Down

When a judge removes the second mortgage or grants an “Avoid Lien Motion” during bankruptcy proceedings it is referred to as “stripping” the lien, a“cram down” or “strip down.”

This can happen if the loan is secured by other collateral that is part of the bankruptcy filing or if the home is not your principal residence or even if the payment structure on the second mortgage falls heavily during the bankruptcy filing period itself.

Here is a Lien Stripping Example:

• Home is worth $300,000.
• The first mortgage is $400,000.
• A second mortgage (or in certain states, a deed of trust) for $100,000.
• Lenders are only secured up to the value of the property. In this case the first lender is secured by the property value.
• The second lender has nothing securing their lien. They are unsecured because the property has no value left over from the first lien. In a Chapter 13, you can lien strip the second lender.
• The second lien is treated as an unsecured creditor.  ( Just like a credit card )
• Most likely the second lender will not be able to collect on the mortgage after the bankruptcy discharge and the homeowners (debtors) still get to keep the house.
• The homeowner would not even have to pay the lien when they sell the house.
• Now, THIS IS A POWERFUL tool for homeowners who are underwater!

Additional liens on your home beyond your initial mortgage, whether you have taken a second mortgage or just another related lien, could be negated in the case of a Chapter 13 personal bankruptcy filing.

Liens can be stripped off of the debtor’s assets in Chapter 11 or Chapter 13 when there is not enough equity in the asset, after deducting senior liens from the property’s current market value, to secure the unsecured in whole or in part, where the lien exceeds the value of the debtor’s property. Section 506 of the Bankruptcy Code acknowledges that a lien is only a secured claim to the extent there is value in the asset to which it attaches. To the extent that the claim exceeds the value of the collateral, that portion of the claim is unsecured. In Chapter 11 or Chapter 13, even voluntary liens, such as mortgages and security interests, can be stripped down to the value of the collateral, with the exception of voluntary liens secured only by the debtor’s residence. Congress is currently considering changes to bankruptcy law allowing the modification of home mortgages.

Despite the general rule, two exceptions may apply so as to allow lien stripping of a mortgage on a personal residence: loans based on a home plus other collateral.

• Lien stripping is prevented only when the lien is secured “solely” by a personal residence.

Court decisions have made it clear that when the debtor has given other collateral (in addition to the personal residence; e.g., office equipment) as security for the mortgage, lien stripping will be allowed. Thus, if you will be taking out a second mortgage or refinancing your home, you should consider offering additional collateral, such as furniture, as security for the loan. This can be done under the guise of seeking better terms from the lender, such as a lower interest rate.

Many (but not all) bankruptcy courts follow a rule that makes a second mortgage totally unsecured if the first mortgage balance equals or exceeds the value of the personal residence. This exception will not apply in the case of a refinancing of a mortgage, since in a refinancing the new mortgage pays off the first mortgage.

The exception is predicated on there being two distinct mortgages (a first and a second mortgage).

For this reason, if you have the option of financing your business through a second mortgage or refinancing your first mortgage, the second mortgage may be the better choice, especially where the amount of the first mortgage is close to the value of the home.