Lien strip in bankruptcy chapter 13 solutions- a true story how one couple saved their house, and erased $200k debt
Chapter 13 review
Bankruptcy is never an easy solution because it means a person has come to the end of their financial options.
When you hit a brick wall, however, filing for bankruptcy may be the only solution.
When you decide to file, there is one thing to consider (in my opinion) that can make a big difference in filing a chapter 13 bankruptcy vs a chapter 7.
The biggest difference between the two chapters is whether you will pay back some of your debt (13), or whether you will walk away from it (7).
There is one other significant difference for a homeowner who owes more on their house than it is worth and has more than one loan on the home.
Financial freedom through debt relief
Chapter 13 summary and what is left out
To know what the code is for a chapter 13 please check out the Federal Government website that explains the Chapter 13 summary here.
As you read the summary on chapter 13 advantages, one thing that is not mentioned is:
How to lien strip a second on your house through chapter 13.
Now I will tell you a story about a couple who filed a chapter 13 and lien strip.
Chapter 13 solutions a true story of how a couple lien stripped their mortgage
As middle aged Bob and Maria (not real names) sat calculating the amount of debt they had after Maria lost her job, they soon realized they were in trouble and didn't know how to get out of debt without losing their house.
They bought their home in California for just over $400k almost a decade ago. At the height of the market, the home had a market value of about $690k.
They refinanced at the top of the market in order to remodel their house. They had a Heloc (second mortgage) from Chase for over $150k. They used most of the money to upgrade their house.
When the market bottomed out and their house value fell to under $290k with a debt of over $550k, their options were limited.
Weighing the options for a solution to debt-
--Maria could try and find another job to replace her lost income but knew that it was very unlikely as she searched for 6 months without success. Bob could get a second job to subsidize the lost income, but at his age was unsure his health could take that many work hours.
--They couldn't sell the house because they owed more than it was worth.
--If they did a short sale they could save their credit because a short sale doesn't damage it as bad as other options. They would lose their home and any chance of equity recovery.
--If they walked away and gave the bank back the keys or allowed a foreclosure their credit would take a huge hit and they would lose their home.
--If they filed chapter 7 bankruptcy they could get rid of their credit card debt but this would not impact their mortgage debt. Their credit report would show the chapter 7 bankruptcy for 10 years. Their credit scores would improve significantly after bankruptcy as time went by.
----If they filed chapter 13 bankruptcy they could keep the house and get rid of the debt on the heloc and their credit card debt. Their credit report would show the chapter 13 for 7 years. Their credit scores would improve significantly after bankruptcy as time went by.
Here were some of the questions Bob and Maria asked before they made their decision:
Chapter 13 bankruptcy and lien stripping
This is why Bob and Maria decided to file a chapter 13 bankruptcy:
The house at the time of filing for bankruptcy had a value of about $350k. The outstanding debt was over $550k. The heloc (second mortgage lien on the house) was over $150k.
$550 (total debt) - $350 (current value of house) = $200k negative equity (under water).
The heloc had the potential to be converted from a "secured debt" to an unsecured debt in a chapter 13 bankruptcy.
Filing for a lien strip in a chapter 13 bankruptcy allowed Bob and Maria to void the $150k-plus heloc debt they owed on the house. They also reduced other debt through the plan, saving them from paying more than $200k in unsecured debt.
In a few years they will have the bankruptcy debt paid back, at which time they should receive a discharge if they make all of their payments according to the bankruptcy plan.
Even though they still owe more on the house than the current market value, over time they hope the value will return to the level of their debt.
The courts have decided that stripping off the unsecured part of a senior lien (your first mortgage on the house) is not permitted.
What are many courts allowing for on junior loans (helocs, equity lines, seconds) that are considered "wholly unsecured liens"?
"The majority of courts that have addressed this issue are in favor of allowing Chapter 13 debtors to strip-off wholly unsecured homestead mortgage liens," according to attorney Robert Schaller.
Choosing a bankruptcy attorney and getting bad advice from bad attorneys
Bankruptcy attorneys come in all flavors. Some are wonderful like chocolate and others are stinky like dog doo. When you decide to file for a chapter 13 bankruptcy, you will probably have to pay a retainer to a decent attorney to start the process.
The fees allowed for bankruptcy attorneys are set and paid through a chapter 13 plan. So if the total you will pay is $4000, most of this will be incorporated into how much you pay back over the next 3 to 5 years while you are in chapter 13 bankruptcy.
How to choose a good attorney for bankruptcy?
The attorney needs to be diligent in filing your paperwork on time or they can damage you. They also need to be up to speed on bankruptcy law. They need to be good communicators. They also need to have staff members who know their stuff. Ask your friends, family and other trusted sources for a referral. Don't be embarrassed to ask for help. You may pay for it in the long run.
This is not the time to go straight to the internet and search blindly for an attorney. You are already in a desperate situation, you don't need to pay for an attorney to add to your troubles. They are paid to give you the best advice the law allows for and you want to get your money's worth.
Maria spoke to one national attorney group that sells "legal and credit protection" for a fee each month, and this "attorney expert" told her there was no way that they could get rid of a mortgage debt in bankruptcy. They should just file a chapter 7 and be done with it. His advice was true regarding the first loan on the house, but completely not true on the second junior loan.
If your attorney is not aware of being able to strip a "wholly unsecured lien" in a chapter 13 bankruptcy, they may not be up on any changes in the bankruptcy law and practices.
Imagine for a minute if Maria and Bob had listened to the first attorney.
They would have filed a chapter 7, gotten rid of credit card debt and still owed the $150k plus on their home.
Because someone else helped them know about a lien strip of a heloc in a chapter 13, they got rid of an additional $150k plus in debt!
So when you choose your attorney, choose one that knows what they are talking about.
Is bankruptcy moral?
One of the hardest parts about filing for bankruptcy is the sense of a moral obligation to pay back a debt you owe. Only you can decide if you believe this is the best option for you.
In the long run, many people get in some difficulties in life. Money seems to be the golden calf in our society. If you made bad decisions or are a victim of circumstance, our legal code allows for you to get out from under debt and have a fresh start.
Disclaimer: My expertise in this area is limited to my background in real estate and the research I did for this article. The information is only based on my opinion. I am not an attorney so the information here is not legal advice. If you are in financial debt, you need to seek the help of a competent professional. I also have no affiliation to any of the sources quoted here. Most sources were chosen for their non-biased information such as government links and consumer sites.
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