Written by Charleston Bankruptcy Lawyer, Russell A. DeMott
Mortgage modification in bankruptcy is a confusing topic. Some say you can. Some say you can’t. As with most bankruptcy issues, the answer is: “It depends.”
However, it’s clear that if you have a wholly unsecured mortgage, you can “strip off” or “value” the mortgage at zero.
Let me give you an example from a recent Summerville bankruptcy case I filed last week. The clients owed $270,000 on a first mortgage and $51,000 on a second mortgage on their residence. Under these circumstances, the law is clear: (1) the first mortgage cannot be modified since it’s a debt secured solely by a mortgage on the clients’ residence, and (2) the second, $51,000 mortgage, can be modified if the property is worth less than what’s owing on the first mortgage (in this case less than $271,000). Assuming that’s the case, the second mortgage is wholly unsecured. In foreclosure, the second mortgage holder would not receive anything. And, in turn, if that’s the case, the second mortgage can be stripped off in a Chapter 13 bankruptcy.
How does this work?
First, it only works in Chapter 13, which is a payment plan bankruptcy. In Chapter 13 bankruptcy, the debtor could “value” the second mortgage at zero because the lender really has no security for the loan. (Remember, the property is worth only $260,000 and the first mortgage is $270,000–$10,000 over the value of the property.)
So the debtor’s plan would provide something like this:
C. Valuation of Security: The debtor moves, in accordance with 11 U.S.C. § 506, to establish the value of a lien as follows:
|Name of creditor and description of property securing lien||Value of Debtor’s interest in property||Holder and amount of superior liens||Estimate of creditor’s claim||Value of lien (see IV(B)(4) below)||Unsecured claim after valuation (see IV(E) below)|
|BAC Home Loans Servicing (Account # 12345 Second Mortgage)Real property commonly known as 123 Main Street, Summerville, SC||$260,000.00||BAC Home Loans Servicing (Account# 54321 First Mortgage)Amount: $271,000||$51,000||$0.00||$51,000|
Under the Bankruptcy Code, the lender is secured to the extent of the value in the collateral. That’s what section 506 of the Bankruptcy Code says, and that’s pretty logical. For example, if a lender uses a car as collateral for a loan, the lender is only secured up to the value of the car. So if the car is worth $10,000, that’s how secured the creditor is in the transaction. So, too, a lender who loans money on real estate and takes a junior mortgage position–2nd or 3rd mortgage–is only secured to the extent of equity to which the mortgage may attach. And in our example above, that’s nothing!
Proving values is very important
Knowing the value of the property–the collateral–in the case is obviously critically important. After all, if I’m wrong about how I valued the property so much that that second mortgage is secured–even partially–then the court will deny my motion to value the mortgage at zero–wholly unsecured. Here, if the home is worth $271,000, then that $51,000 second mortgage is not wholly unsecured. It’s what we call “undersecured.” Still, it’s secured rather than unsecured. For this reason, we had an appraisal done and are confident of our valuation. The home is in an established Summerville neighborhood with over fifty homes, so values are relatively easy to determine.
The 4th Circuit Court of Appeals recently upheld a debtor’s right to strip off a second mortgage
Just this past week the Fourth Circuit Court of Appeals (the appellate court below the U.S. Supreme Court for Maryland, Virginia, West Virginia, North Carolina and South Carolina) upheld a lower court decision allowing a second mortgage to be stripped off in a Chapter 13 plan. In that case, Suntrust Bank challenged a Maryland debtor’s right to strip off a second mortgage. The Bankruptcy Court allowed it, and the decision was affirmed by the District Court. SunTrust appealed to the Fourth Circuit, which summarily held:
SunTrust appeals the district court’s order affirming the bankruptcy court’s order granting the Debtors’ Motion to Avoid Lien. We have reviewed the record and find no reversible error. Accordingly, we affirm for the reasons stated by the district court. SunTrust Bank v. Millard, No. 8:08-cv-03002-MJG, 08-17964 (D. Md. Nov. 7, 2008 & Sept. 28, 2009).
So mortgage stripping in South Carolina is alive and well, provided the facts (valuation and loan balances) justify it. If you have a second mortgage and wish to keep your home, talk to a bankruptcy lawyer about your options. Given the fact that out-of-court modification isn’t always successful, the only real opportunity may be under the Bankruptcy Code.
hmmm, don’t know if this is really where to leave this info, but assuming an attorney will read this and comment back to me:
My situation: I had the Amish build me a custom built log home in 1999, that’s almost 5,000 sq ft and is located on 12 acres in Polk Co., IA. Citimortgage hold’s 1st mortgate at $602,000 and CityBank holds second mortage at $42,000. Am paying 2.75% on mortgage modification loan for a year now, an in process of applying for mortgage modification loan on 2nd mortgage now. Got county tax assessment lowered to house value of $368,000 with land value at
$90,000. for a total property assessed value at $458,000. I am 61 years old and need to downsize
to a smaller property due to living on fixed income for life from a structured annuity and disaility income. If I cannot sell my home without taking a huge loss before 2013 and possibly would then have to pay tax on the difference from what I owe and what the house actually sells for, maybe
$450,000 sold and owe around $640,000? I don’t want to have to pay uncle sam tax on $190,000.
which is the difference. Should I check into a short sale, or bankruptsy before 2013, or foreclosure?
I really need to know which would be the best way for me to go. There is little money left now after I pay my monthly bills and I’m thinking I would be better off renting at this time in my life. I do hope someone will read this who can give me some sound advise. Thank you in advance for reading and considering this information. Sincerely, Cheryl Roe
Thanks for commenting. You have a very complicated situation and need to discuss this with a bankruptcy lawyer in IA. What you do largely depends on other facts I don’t know about, like your income and other debt issues (unsecured debts, for example). You need to discuss your entire financial situation with a local attorney face to face in a 1-2 hour meeting. I wish you the best. Thanks for commenting.
My husband and I are half way through a Chapter 13 bankruptcy. We surrendered our home a year ago but now find we are still the legal owners. We have a 2nd note on our mortgage. My question is: Can we move back into our vacant home for the next 2 1/2 years until we are discharged from the bankruptcy or can our first mortgage holder, who received a court order lifting the stay on our mortgage a year and a half ago but haven’t started foreclosure proceedings, file foreclosure documents on us at any time – or do they have to wait until the bankruptcy (second mortgage will be stripped) is discharged?
You need to contact an attorney in your area. I can’t give you legal advice. I wish you the best.
I have a situation that I continue to get conflicting answers on.
My wife and I were forced into a chapter 7 in South Carolina due to job loss in which we also surrendered our home. There was a first and second mortgage. The chapter 7 discharged 4/2010. We were current at the time but ended up having to relocate for a new job so the home became un occupied. The home though didnt come out of our name until 4/2012? When does this seasoning start? I have been told 4/2012. I am trying to do a usda guaranteed loan for which I have also been told for that they use the discharge date when home is included in chapter 7? Can you enlighted me on this? Thank you
I assume by “seasoning” you are asking when the clock starts for the waiting period for getting a new loan. It should be be governed by the discharge date because you would fall under the bankruptcy rule. For FHA loans (and I assume ASDA loans) the waiting period is usually two years post discharge and three years post foreclosure. FHA recently shortened this to as little as one year with some hardship reason for the financial problem. (And I have no idea how they determine what events qualify.) I do see some originators and underwriters referencing the foreclosure date with bankruptcy situations like yours. This is incorrect. You discharged your liability for the mortgage note in 2010. As long as you, at the time you apply, do not still own the home (you can’t own two homes and qualify) then they should reference the bankruptcy discharge date. If they don’t, the fact that you filed bankruptcy (other than helping your debt/income ratio) would be meaningless. Net/net, I see no logical or legal reason why they should treat you as if you never filed bankruptcy. The specific bankruptcy rule (two years) should control over the foreclosure rule (three years). Why? Because when you received your discharge, you had no liability on the mortgage note any more. So what difference would it make if they foreclosed in 2010 or 2012? Why would that be probative of anything, such as your credit worthiness for the new loan? You had NO legal responsibility to pay that mortgage after 2010 when you received your discharge. Someone needs to take this issue up with FHA or USDA because the underwriters are not thinking this through, or blindly following what they think is the rule. It would make sense to apply the foreclosure rule if you had not filed bankruptcy, but because you filed bankruptcy, you should fall under the bankruptcy rule. If you can’t get this resolved, apply again through another mortgage company. You may also want to address it directly with USDA, FHA or contact constituent services of your House Rep. or Senator.
thank you so much for that explanation! its the best one I have had to date!