In my last post I discussed the three basic requirements a Chapter 13 plan must meet to get confirmed. In this post I will discuss a powerful Chapter 13 tool that has no Chapter 7 analogue: lien stripping. (No, it’s not X-rated.)
I. Lien Stripping On The Debtor’s Primary Residence
First the bad news: In Nobelman v. American Savings Bank, 508 U.S. 324 (1993) the U.S. Supreme Court held that an under-secured – i.e., “partially secured” – mortgage on the debtor’s primary residence is protected up to the full amount of the debt in the sense that the unsecured portion cannot be stripped off.
Now the good news: Any wholly unsecured mortgage on the debtor’s primary residence can be stripped off and treated as if it were ordinary general unsecured debt. Thus, a second mortgage can be stripped off, put into the Chapter 13 plan, and paid off at the same percentage as the other general unsecured debts – which is usually a small percentage. This means that the debtor can have the second mortgage extinguished in five years, after having paid only a small percentage of that mortgage.
The key element in a Lam motion is to show that the second mortgage is 100% unsecured. To do this the debtor must establish that the current balance on the first mortgage is greater than the value of the house. If there is even one dollar of house value behind the second mortgage, the lien cannot be stripped. As a consequence, if the value of the house is very close to the current balance on the first, the holder of the second mortgage will put up a fight over the value of the house.
It is important to get an unbiased appraisal – not from the debtor’s friend or relative – from an appraiser who is willing to sign a declaration under penalty of perjury regarding the value of the property. This is important because the appraisal by itself, without the declaration, is inadmissible hearsay.
One cautionary note is in order: When the debtor strips off a second, the second becomes an unsecured debt for plan purposes. This means the unsecured debt will now be much larger than what was originally listed in Schedules E and F. The result could render the debtor ineligible for Chapter 13 relief if the unsecured debt now exceeds the $360,475 limit found in 11 U.S.C. § 109(e). Therefore, before stripping off the second be sure that you won’t end up destroying the entire Chapter 13 bankruptcy.
II. Lien Stripping Other Than On The Debtor’s Primary Residence
A Chapter 13 debtor is permitted to modify the rights of secured creditors as long as the collateral is not the debtor’s primary residence. See 11 U.S.C. § 1322(b)(2). For example, the debtor can modify the terms of an under-secured mortgage on rental property.
However, unless the creditor agrees otherwise, the debtor must pay the entire modified debt in equal monthly payments over the life of the plan – which, as we have already seen, in Chapter 13 cannot exceed sixty months . This requirement makes it unlikely that most debtors will attempt to modify a mortgage on rental property in a Chapter 13.
In my next post I’ll discuss another way to strip off a second mortgage in Chapter 13: rescission. Stay tuned.