Does Filing for Bankruptcy Wipe Out My Mortgage

Many people facing financial hardship wonder if filing for bankruptcy will eliminate their mortgage. This post will explain the difference between secured and unsecured debt in bankruptcy, and how Chapter 13 bankruptcy can be used to reduce or eliminate a second mortgage under certain circumstances. The process of lien stripping a mortgage will also be discussed and the common mistakes debtors make with the Order of Discharge.

Updated on December 13, 2024.

Key Points:

• The Order of Discharge is a generic template issued by the bankruptcy judge. It doesn’t mean all debt has been discharged.
• Secured debt is not discharged in bankruptcy.
• Chapter 7 bankruptcy will only stop a foreclosure temporarily.
• Chapter 13 bankruptcy will help you catch with your missed mortgage payments.
• Lien stripping is a powerful tool that could help you reduce a second mortgage.

After all these years of practicing law, I realized that whether it is in family law or bankruptcy law, clients tend to get a piece of information and apply it to their situation. Law students also have this problem, and as any law professor can confirm, we are always repeating to students to avoid being “conclusionary,” meaning they went from A to C, skipping B, which is the most important part. For law students, it’s a lower grade, but the results at times have been disastrous for debtors who filed for bankruptcy without a lawyer.

For example, many times, I have come across situations where the client has received an Order of Discharge, which means their case has been finalized and approved by the bankruptcy court; however, one day, the debtor receives a collection letter or is even served with foreclosure by the second mortgage lender. The debtor is unsure why there is a foreclosure if they received the Order of Discharge. However, the Order of Discharge is a standard template signed electronically by the bankruptcy judge.

Order of Discharge, Official Bankruptcy Form 318

Above, you can see a screenshot of the first page of the Order of Discharge. The highlighted section points to the heading “Most debts are discharged.” Self-represented debtors sometimes believe this includes their mortgage, but again, that’s going from A to C, skipping “B.”

Now look at the second page of the Order of Discharge with the highlighted sections.

Order of Discharge, Official Bankruptcy Form 318

The Order of Discharge makes clear that not all debt is dischargeable. For example, in a prior post, I compared the case of rapper G Herbo and his guilty plea and conviction for criminal fraud and that cases involving fraud and that the fines imposed by the court are non-dischargeable debts.

However, because the Order of Discharge doesn’t reference second mortgages, debtors sometimes believe they wiped out their second mortgage and stop making payments on the second mortgage after receiving their Order of Discharge, but secured debts are not dischargeable in bankruptcy.

What is Secured Debt?

Secured debt I’ve always told my bankruptcy law students and clients are debts that are “secured”  to something. For example, a car loan is secured by the car, and the mortgage secures the house. This is different from a credit card or personal loan that isn’t attached to any specific assets. Thus, credit cards and personal loans are considered unsecured debt.

How Do I Eliminate My Mortgage in Bankruptcy

If you file for Chapter 7 bankruptcy and are keeping an asset secured by debt, for example, a house or car, that debt will not be wiped out with the bankruptcy filing. The confusion for debtors is based on two situations.

The first situation is that they read online or know someone who wiped out their mortgage or car loan when they filed for Chapter 7 bankruptcy but do not realize that’s because the asset was surrendered to the trustee or the original creditor.

Issues with a Divorce Case, Mortgage, and Bankruptcy

The second situation applies in limited situations where the second mortgage, or what is known as an inferior mortgage, can be reduced, maybe even eliminated. Because there is already a first mortgage on the house, additional mortgages are known as inferior mortgages.  This is possible with Chapter 13 bankruptcy.

What is Chapter 13 Bankruptcy

A Chapter 13 bankruptcy is sometimes called a “reorganization” or a “wage earner’s plan” since income is required to qualify for Chapter 13. Chapter 13 is a court-approved payment structure of three to five years that helps reduce or eliminate debt. However, note that Chapter 13 can be very complicated, and it’s not recommended that a debtor files for Chapter 13 without a bankruptcy lawyer as the success rate is less than five percent.

So When Can a Second Mortgage be Reduced in a Chapter 13 Bankruptcy? What is Lien Stripping?

For second mortgages to be reduced in a Chapter 13 bankruptcy, what is known as lien stripping is when the current fair market value of the home is less than the balance due on the 1st and second mortgages.

Example 1 –

• Say the house is worth $300,000 and has a first mortgage of $310,00. Regardless of what is owed on the first mortgage, lien stripping doesn’t apply because there is no inferior or second mortgage.

Example 2 –

The house is worth $300,000. The first mortgage has a balance of $200,000, and the second mortgage has a balance of $25,000. That means there is $75,000 in equity, the difference between the house’s value minus the mortgage debt. So, the equity is the part that belongs to you, and you would get with the sale of the house.

In this case, lien stripping wouldn’t apply either because there’s equity in the house, even with a second mortgage of $25,000.

Example 3-

The house is worth $300,000, the first mortgage is $275,000, and the second mortgage is $50,000, so the total balance of the mortgages is $325,000. Because there is more owed on the house than what it is worth, that is known as negative equity, meaning there is no equity, which is common with cars because the value of autos depreciates quickly.

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In this case, half of the second mortgage, or $25,000, is subject to lien stripping, or the amount the second mortgage can be reduced by. Why? Notice that part of the second mortgage makes the house worth less than what is owed. With no equity in the house, even if the homeowner wanted to sell the house, they couldn’t because there was no equity. This is known as an underwater mortgage.

Issues with a Divorce Case, Mortgage, and Bankruptcy

Underwater mortgages caused the foreclosure crisis of 2008 since homeowners owed more on their homes than the value of their houses, so they walked away. This caused a wave of foreclosures throughout the country, with some cities and counties hit harder than others. For example, in Miami, Florida, where I lived most of my life, home values decreased by more than 50%, and guess who was one of those hundreds of thousands of people who walked away from their mortgage? If you guessed me, you’re right. It just did not make sense for me personally to maintain a large home with an underwater mortgage.

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Going back to our third example. With part of the second mortgage that eliminates the equity in this house, in this case, $25,000 is stripped or reduced, meaning the second mortgage is now $25,000 plus the balance on the first mortgage. Remember, a first mortgage is not reduced or lien stripped. The $25,000 of the second mortgage that was stripped becomes unsecured debt as part of the Chapter 13 bankruptcy, and now the combined mortgages equal the home’s fair market value.

The Benefits of Filing Chapter 13

While there may be many reasons why a debtor has to file Chapter 13 instead of a Chapter 7 bankruptcy, one definite advantage of Chapter 13 is the power of lien stripping. Unfortunately, that’s where debtors who filed for bankruptcy without a lawyer get confused and believe it applies to their Chapter 7 cases. However, Chapter 7 does not offer lien stripping on any debt, whether the debt is secured or unsecured.

Lien Stripping is not Automatic

When a Chapter 13 bankruptcy has been filed, whether the debtor, the mortgage lender, or the trustee knows that lien stripping applies to a particular case, that process is not automatic. A lien strip motion must be filed and argued before the bankruptcy judge. If the lender agrees, then there wouldn’t be an issue, but the lender does have the right to object to lien stripping, and at that point, an appraisal is done on the property to confirm its value.

I hope this article on Chapter 13 and lien stripping helps you better understand the process. If you have any questions, please get in touch with me so I can post and answer them in the Readers Forum.

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Please note the information on this site does not constitute legal advice and should be considered for informational purposes only.