When Removing a Second Mortgage in Chapter 13 Bankruptcy Is Not a Good Idea
Filing for Chapter 13 bankruptcy in order to get rid of a second mortgage or HELOC is not always in your best interest.
If you satisfy certain requirements, filing for Chapter 13 bankruptcy can allow you to get rid of your second mortgage (or other junior lien) through a process called lien stripping. Lien stripping is a powerful tool in bankruptcy. But it may not be the right choice for everyone. Read on to learn more about when lien stripping may not be in your best interest. (For more information on what happens to your mortgages in Chapter 13 bankruptcy, see Your Home and Mortgage in Chapter 13 Bankruptcy.)
What Is Lien Stripping?
Lien stripping is a process that allows qualifying Chapter 13 debtors to remove wholly unsecured second mortgages, home equity lines of credit (HELOCs), home equity loans, or other junior liens from their house. In general, to qualify for lien stripping, the balance of your first mortgage (or other senior liens) must exceed the value of your home so that your second mortgage is wholly unsecured. In addition, you typically have to complete your Chapter 13 repayment plan and obtain a discharge before the lien can be removed. (To learn more about how lien stripping works, see Getting Rid of Second Mortgages in Chapter 13 Bankruptcy.)
When Lien Stripping May Not Be in Your Best Interest
Lien stripping is often a very desirable aspect of Chapter 13, but not always. The following are some of the most common situations where filing for Chapter 13 bankruptcy to strip your second mortgage may not be in your best interest.
You Make Too Much Money
When you strip your second mortgage, it’s treated as a nonpriority unsecured debt (like your credit card debt and medical bills) in Chapter 13 bankruptcy. The amount of unsecured debt you must repay through your Chapter 13 plan depends on many factors including your disposable income. (For more information, see Unsecured Debt in Chapter 13: How Much Must You Pay?)
If your disposable income is too high, you may be required to pay back all or a significant portion of your unsecured debt (including your stripped second mortgage) through your repayment plan over the next three to five years. In that case, it may not make sense for you to file for Chapter 13 bankruptcy to strip your second mortgage.
You Will Not Be Able to Complete Your Repayment Plan
To get rid of your second mortgage lien, you typically need to complete your Chapter 13 repayment plan (which can take three to five years) and obtain a discharge. If you don’t make your monthly plan payments and your Chapter 13 gets dismissed prior to completion of your plan, your second mortgage will not be stripped.
This means that if you believe you will not be able to complete your Chapter 13 plan, lien stripping may not work for you. When you strip your second mortgage in Chapter 13 bankruptcy, you are not required to make payments to that creditor outside of bankruptcy. But if your bankruptcy gets dismissed and the second mortgage remains on the property, you will usually be significantly behind on your payments and may not be able to catch up.
You Have Good Credit and Can Afford Your Second Mortgage
If you currently have good credit, filing for bankruptcy relief can negatively affect your credit score and ability to obtain favorable financing. For this reason, it’s not a financial decision you should take lightly.
In general, if you have good credit, a modest second mortgage with a good fixed interest rate, and can afford your monthly mortgage payments, it may not be in your best interest to file for bankruptcy solely to take advantage of lien stripping. But if you have a large, high-interest second mortgage that you can’t afford, or if you need to file for bankruptcy because of additional reasons, it might make more sense.