If you file for Chapter 7 bankruptcy, you generally cannot get rid of second mortgages, home equity lines of credit (HELOCs), or home equity loans. However, due to a a few recent bankruptcy cases coming out of the Eleventh Circuit Court of Appeals, you may be able to strip off (remove) these types of liens in Chapter 7 if you live in Alabama, Florida, or Georgia.
(Learn more about what happens to your home and mortgage in Chapter 7 bankruptcy.)
Lien stripping is a powerful tool that is usually only available in Chapter 13 bankruptcy. With lien stripping, you are allowed to get rid of junior liens on your home if they are wholly unsecured. What exactly does this mean?
What is a junior lien? Junior liens are anything other than your first mortgage. So they would include second or third mortgages, HELOCs, and home equity loans.
What does wholly unsecured mean? A lien or security interest is wholly unsecured if the equity in your property does not cover any of the lien amount. For example, say your home is worth $500,000, your first mortgage is $550,000, and your second mortgage is $50,000. Since your first mortgage is greater than the equity in your home, there is no equity left to cover your second mortgage. If the lender were to foreclose on your home, the first mortgage holder would get $500,000 and the second mortgage holder would get nothing.
What happens to the junior mortgage? If a junior mortgage or home equity line is eligible for lien stripping, the formerly secured debt becomes unsecured debt.
To learn more about lien stripping, see the articles in Your Home and Mortgage in Chapter 13 Bankruptcy.
In most bankruptcy jurisdictions, you cannot strip off junior liens in Chapter 7 bankruptcy. However, several recent decision in the Eleventh Circuit Court of Appeals ruled that lien stripping could be available to Chapter 7 bankruptcy debtors as long as none of the lien is secured. In Re McNeal, Case No. 11-11352 (11th Cir., May 11, 2012); In re Sinkfield, No. 13-12141 (11th Cir. July 30, 2013). But the reality is that most courts do not follow these rulings, especially since the Sinkfield case has been appealed to the United States Supreme Court.
If you can remove a junior lien in Chapter 7 bankruptcy, the amount of the lien becomes part of your unsecured debt. In most cases, this debt is discharged at the end of your bankruptcy case. (To learn more about what happens to unsecured debt in Chapter 7, see our Chapter 7 bankruptcy area.)
States within the Eleventh Circuit include Alabama, Florida, and Georgia. If you are filing for bankruptcy in one of these states, you may be able to strip off junior liens in Chapter 7 bankruptcy. Some judges allow debtors to do this. But many others argue that because the McNeal case is unpublished, it's only persuasive authority and does not have to be followed. This means that whether you can strip a lien in Chapter 7 bankruptcy in the Eleventh Circuit is up in the air -- check with a local attorney to find out what your court routinely does.