Stripping a Second Mortgage in a Chapter 13 Bankruptcy

Many people have taken out a second mortgage on their home. These second mortgages are usually referred to as home equity loans, because they are based on the amount of equity you have in your home. Your original mortgage loan’s value vs what your home is worth, along with your credit score determines how much money you can borrow through a home equity loan.

Typically, these loans are paid to homeowners in one lump sum so they can do home renovations or repairs. Some people use home equity loans to pay off a large debt with a high interest rate or to buy a vacation home. A home equity loan can seem extremely advantageous if you’re in need of some fast money, however the danger is that if you fail to repay the loan, you could lose your house.

Getting in over your head with your mortgage has been a popular theme in the past decade, so if you’re finding that you can’t make both your first and second mortgage payments, you’re not alone. Luckily, you do have some options.

If you could eliminate your second mortgage, would that make your monthly living expenses doable? Wishing you never took out that home equity loan? Filing for a NJ chapter 13 bankruptcy might be right for you.

A process known as ‘lien stripping’ can essentially erase that second mortgage, but this process is only available to debtors who file for chapter 13 bankruptcy. Additionally, in order to qualify for a lien stripping, your first mortgage balance must be higher than the current value of your home.

For example, if your first mortgage balance is $300,000, but your home is currently worth $275,000, you have zero equity in the property. In fact, you’re said to be ‘upside-down’ or ‘under water’ in regards to your first mortgage.

A $25,000 second mortgage would qualify to be stripped via chapter 13 bankruptcy in New Jersey. Upon application for a chapter 13 bankruptcy, your debts will be reorganized so that you can afford your monthly payments on all of your secured debt. In a chapter 13 bankruptcy, a second mortgage is referred to as a junior lien, and will be lumped in with all of your unsecured debts.

Throughout your chapter 13 repayment plan, you only have to pay a percentage of the total lump sum of all of your unsecured debts because they are considered “non-priority” debts. Upon successful completion of your bankruptcy payment plan, you will be granted a discharge. A chapter 13 discharge will put the lien strip into motion, and you will no longer be responsible for any remaining balance on your home equity loan or second mortgage.

The same is true for homeowners who also have a third mortgage on their home. If you want to stay in your home and would be able to afford your mortgage plus monthly living expenses if only you could “get rid of” your second or third mortgage(s), ask George about filing for a NJ chapter 13 today. You only have debt to lose!

 

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Second Mortgages After Foreclosure: Who Pays?

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What is a second mortgage?

Oftentimes, when applying for a home loan, first time home buyers don’t have enough money to make a substantial down payment. Typically, lenders don’t like to grant loans for more than 80% of the price of a home. Lending so much money to a borrower is risky, so banks who do so will require that the buyers purchase private mortgage insurance (PMI). Mortgage insurance is expensive, so borrowers try to avoid it by applying for two separate mortgage loans. The first loan granted is usually for a maximum of 80% of the purchase price, while the second mortgage covers the remaining cost of the home – typically around 20%.

Who can get a second mortgage?

In order to be approved for a second mortgage (also referred to as an 80/20 loan), you must have a very good credit rating. Because you won’t be making any down payment, you are a higher risk to your lenders. A high credit score (above 700) puts lenders at ease, knowing that you have a solid credit history.

What happens to a second mortgage after foreclosure?

Even well-qualified buyers can experience foreclosure. As they say, “Life happens,” and a variety of factors may cause you to become unable to continue making your monthly mortgage payments even if you had great credit when you bought your home. For example, you may have experienced:

  • Divorce
  • Chronic illness
  • Accident or injury that permanently reduced your earning potential
  • Job loss
  • Unforeseen expenses (death or disability of a close relative, job transfer, etc)

Upon foreclosure of your home, your primary mortgage lender (80%) will sell your home at Sheriff’s Sale/Foreclosure Sale in order to recoup at least some of the money you borrowed but were unable to repay. Any sale proceeds that exceed what you owed your primary lender will be used to pay back your second mortgage lender.

Home sold at foreclosure sale almost always sell for less than they are worth. This means that second mortgage lenders often don’t see any proceeds from foreclosure sales. The second lender is left holding the (empty) bag, as the saying goes.

Will I have to repay the second mortgage if the foreclosure sale price is below market value?

Naturally, this is a pressing question for homeowners who’ve lost their homes to foreclosure. No one decides to go through foreclosure because they have plenty of money floating around. If you’ve lost a home to foreclosure, you’re understandably concerned about the potential of a deficiency judgment.

A deficiency judgment is a legal action that a lender can take against you for the amount of money they lost when your home was sold at Sheriff’s Sale. Many lenders will write off the loss due to the cost and hassle of mounting a legal action. However, some lenders do indeed pursue a lawsuit against defaulted borrowers whose homes were sold at foreclosure for less than the amount still owed.

How can I repay my second mortgage? I’m already in financial distress!

If your second mortgage lender has threatened you with legal action unless you pay up, you need to be proactive by retaining counsel. You can file for bankruptcy, which will automatically prohibit ALL of your creditors from attempting to collect money from you. Your NJ bankruptcy attorney can also take other action to settle your second mortgage debt if you wish to avoid chapter 7 bankruptcy.

Image credit: Chris Potter

Am I Risking Foreclosure for Non-Payment of a Home Equity Loan?

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As we’ve talked a lot about here on our law blog, failure to make your home mortgage payments on time can quickly lead to your lender filing a foreclosure case against you. Lenders file foreclosure on non-paying debtors in order to repossess the home that was purchased with the borrowed money. After they officially foreclose and evict you for non-payment, your lender will put the property up for a foreclosure sale – also known as a Sheriff’s Sale. This allows the lender to recoup at least some of the money that you owe.

Now let’s discuss the concept of a second mortgage (sometimes called a home equity loan). Most second mortgages are taken out by homeowners in order to pay for home repairs or improvements. Some second mortgages are taken out to buy a second home. Second mortgages can also be used to repay a significant debt. It’s never a good idea to take out a home equity loan for something impractical like an extravagant vacation, but it has been done.

Second mortgages, a/k/a home equity loans, are attractive to homeowners because of their relatively low interest rates. Since you’ll be using your home as collateral for the loan, you can usually borrow a significant amount of money this way without having any limits or rules regarding how you use the funds. Also, any interest you pay on this type of loan is often tax deductible.*

Can I lose my home to foreclosure if I default on my second mortgage?

If you’ve had a significant life event that has had an impact on your finances, such as job loss, divorce, injury, disability, etc – it can be tempting to stop making the payments on some of your debts.

Although it may seem like an acceptable option when you’re strapped for cash, failure to make your monthly second mortgage payments can have catastrophic results. Unfortunately, many people do not know what can happen if they stop paying their home equity loan.

Even if you only plan to miss several payments so that you can “catch up” on some of your other financial obligations, your second mortgage lender has every right to begin foreclosure proceedings. Whether they will initiate a foreclosure depends on how much (if any) equity exists in your home.

What is “equity”?

To have “equity” in your home simply means that your home is currently worth more than you still owe on the original (first) mortgage.

If your home has at least some equity when you start missing payments on your home equity loan (second mortgage), your second mortgage lender is likely to foreclose on the property, hoping to salvage at least a portion of the amount you still owe.

Supposing your home has no equity, the second mortgage lender is unlikely to proceed with a foreclosure because they wouldn’t receive any money recovered through the Sheriff’s Sale. In this situation, the original mortgage lender would almost always file for foreclosure and they would be entitled to any funds recovered.

If your home is underwater when you stop making payments on your home equity loan, your second mortgage lender still has a right to money they are owed. Often in these situations, second mortgage lenders will sue delinquent debtors for the amount still owed on the home equity loan. Your wages may be garnished in order for the lender to recover their losses.

 

*Always check with your tax advisor.
Image credit: A.Eelectrik