I have heard a lot about stripping second mortgages in bankruptcy. How does this work?

This is called a lien strip. When you obtain financing for a piece of real property, generally the lender will record what is called a deed of trust against the property. The deed of trust suffices as security for the large loan. Most deeds of trust contain “power of sale” clauses, which, in the event of a default, allow the lender to non-judicially foreclose on the property. Many times a single piece of property may have multiple mortgages or liens against it. Liens are entitled to priority based on when in time they were recorded. Second mortgages and home equity lines of credit (large loans obtained by borrowing against a property’s equity) are often “junior” to the senior purchase money mortgage.

If the fair market value of the property is less than or equal to the balance due on a first mortgage, a debtor may seek to strip a junior mortgage in bankruptcy, the reasoning being that there is absolutely no equity remaining to secure the junior mortgage after the first is accounted for. The debtor moves to value the junior lien at zero dollars, and essentially converts the once-secured debt to unsecured debt, much like credit card debt. However, this is only available in a chapter 13 or 11, and the debtor may or may not still be required to pay a portion of that debt through his or her plan. Please contact me if you have more questions regarding this procedure, or go here to learn more.