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Strip-Off that second mortgage in a Chapter 13
A Cram-down, commonly referred to as a “strip-off,” is when a debtor strips off and avoids the secured status of the second mortgage because there is insufficient value in the property to secure any part of it. This is a great way for an underwater homeowner to dry out their property as will be explained further in this post.
Debtors have the ability to cram down second mortgages in Chapter 13 bankruptcy cases pursuant to Bankruptcy Code § 1322(b)(2). Unfortunately the New Jersey District court has joined a majority of courts, when it ruled in Cook v. IndyMac Bank, that the debtor, Cook, could not use section 506(d) of the Bankruptcy Code (the “Code”) to “strip off” a wholly unsecured junior lien.
It is the Chapter 13 plan which will “strip-off ” the second mortgage. In New Jersey it is not required to file an adversary proceeding to do so. A debtor may modify a secured creditor’s claim and cancel its lien to the extent permitted under 11 U.S.C.S. §§ 506(a),1325 by so providing in a chapter 13 plan without an adversary proceeding, objection to claim, or motion under Fed. R. Bankr. P. 3012. Lee Servicing Co. v. Wolf (In re Wolf), 162 B.R. 98 (Bankr. D.N.J. 1993)
In order to cram down a second mortgage, the house must be underwater to the extent that there is no equity whatsoever covering the second mortgage. In other words, the value of the house must be less than the balance due on the first mortgage.
The debtor provides evidence of the homes value by supplying the Court with documentation supporting the valuation of the home. When a mortgagee (lender) challenges the appraisal, which is not common, then the Bankruptcy Court will schedule an evidentiary hearing. At this hearing the Court decides what the value of the property is. The defense of the second mortgagee will most likely be that the debtor’s appraisal is inaccurate, and that the house is actually worth at least a dollar more than the balance due on the first mortgage.
Here is a real example of Lien Stripping in New Jersey*:
A single person was living in her home. Her home had a market value of $200,000. Her first mortgage has a principal amount of $180,000 and her second mortgage had a principal amount of $80,000. The first mortgage was secured by the property value. Initially it appears that the second mortgage does have value in the home that secured its lien.
However, the second mortgage was completely unsecured because even though there was equity of $20,000 remaining after the first mortgage, in New Jersey the debtor can use his/her homestead exemption which protects $21,625 above the first mortgage (for a married couple filing jointly this amount would be doubled). In this case the debtor was protected for a home value up to $201,625.
So in this Chapter 13, we filed a plan stripping the second mortgage. The second lien was subsequently treated as an unsecured creditor. In this case the 2nd mortgage will received pennies on the dollar. The plan proposed was a 5% plan, the 2nd mortgage holder was to receive $4,000 (5% of $80,000) over a 5 year period and then nothing more. After this bankruptcy is discharged, meaning they stick to and complete the Chapter 13 bankruptcy plan the homeowner/debtor will get to keep her house. At the end of her plan her home would have dried out the second mortgage.
*Numbers, percentages and parties changed for simplicity.
The New Jersey personal bankruptcy attorneys at Riviere Cresci & Singer LLC can answer any questions you may have concerning filing Bankruptcy, or any general bankruptcy questions. If you live in New Jersey, including Howell, Jackson, Monroe, Manalapan and Freehold call us for a free consultation to find out how we can help you.