November 25, 2017

What is “Lien Stripping” and Can I Use it to Reduce my Mortgage Payments

mortgage lien stripWith the decline in Atlanta area housing values, a seldom used bankruptcy technique has taken on new life.  The technique is called “lien stripping” and it arises from Bankruptcy Code Section 506(a) and (d).  A lien strip allows a Chapter 13 debtor to use the power of the Bankruptcy Court to transform a secured second mortgage or home equity line of credit into an unsecured debt, thereby eliminating a monthly payment and reducing total debt by tens of thousands of dollars.

Here’s how it works: Let’s say that you own a home worth $250,000.   Perhaps that home was worth $350,000 three or four years ago but its market value has dropped because of the recession.  The balance on the first mortgage is $270,000 and the balance on the second mortgage is $45,000.

In this case, a Chapter 13 debtor can ask his bankruptcy judge to “strip away” the second mortgage debt since all of the value in your home is encumbered by your first mortgage.  In other words, if you were to sell your house, the first mortgage lender would not be paid in full and the second mortgage lender would get nothing.  The second mortgage lender is, therefore, unsecured. [Read more…]

Are Mortgage Modifications in Bankruptcy a Good Idea – Part One

There has been a lot of chatter on bankruptcy blogs and bankruptcy lawyer forums about the possibility that Congress will amend the bankruptcy laws to give judges the power to modify mortgages.   To offer some perspective, bankruptcy judges have long had the power to modify vehicle loan contracts and other secured debt claims but never mortgage debt.

When I first started practicing bankruptcy law some 20 years ago, I was introduced to the term “cram down” which is a kind of bankruptcy lawyer slang for the process of forcibly changing the terms of a contract against a creditor’s interests.  In a typical car loan cram down, you might enter into bankruptcy with four years remaining on a five year note, a monthly payment of $530 per month, an interest rate of 12% and a total outstanding balance of $28,000.   After cram down the interest rate might be 6% and the outstanding balance may be $18,000 (which represents that approximate value of the vehicle) and the monthly payment to the creditor within a Chapter 13 plan might be $250 per month.

As you can see from this example, the purpose of a cram down is to bring a debtor’s obligation more in line with the value of the collateral and prevailing interest rates.  I suspect that Congress allowed cram downs on car loans because it saw a problem in the market place whereby consumers with poor credit were ending up with unreliable used cars at unreasonable terms in the secondary market.

Debtor’s attorneys also included cram down provisions in Chapter 13 plans to modify the terms of other secured loans, such as furniture and jewelry.  However, home loans were specifically excluded from cram down.

In 2005, with the enactment of the BAPCPA changes to the bankruptcy laws, Congress added restrictions to the power of judges to cram down vehicle purchase loans.   In other words the era of freewheeling bankruptcy cram downs was over.   Under the amended law, vehicles purchased less than 910 days prior to the filing of a bankruptcy case were not subject to cram downs.

These new restrictions on the authority of a judge to forcibly modify the contractual terms between a debtor and his car finance company were the result of extensive lobbying on the part of the automobile industry who argued that market forces, not bankruptcy judges ought to set the terms of vehicle purchase financing.

There has been no organized effort to change the rules regarding vehicle cram downs.   Instead, Congress has turned its attention to mortgage loans.   Perhaps this is not surprising since the federal government, through its mortgage guarantees, now owns or controls a fairly significant chunk of mortgages owed by Americans.

Legislation is now circulating in Congress that would allow a bankruptcy judge to change the terms of a mortgage, which would involve such things as:

  • reducing the outstanding balance to line up with the current market value
  • modify the terms (monthly payments)
  • change the interest rates

The sense among bankruptcy lawyers is that if this legislation makes it into law, Chapter 13 bankruptcy will become a viable and attractive option to middle class families who might never have considered bankruptcy relief.   Mortgage debt is often a family’s largest obligation and an opportunity to “re-write” one’s mortgage at more favorable terms while at the same time reducing credit card debt and canceling unfavorable leases and service contracts may very will put the bankruptcy option on the table.

Is it a good idea to enable mortgage loan cram downs?   If you have a mortgage and have been contemplating bankruptcy should you wait?  We’ll explore those questions next….

Congress Considers Bill that Would Allow Homeowners to Modify Mortgage Terms in Chapter 13

Jonathan Alper, writing in the Florida Bankruptcy Law blog, reports that Democratic congressmen have introduced House Bill 7307 which would empower bankruptcy judges to reduce the balances of “upside down” mortgages to the value of the property and to reduce mortgage interest rates in some cases.

So called “cram down” authority currently allows bankruptcy judges to cram down car loans, furniture debt and other secured loans.  The BAPCPA changes to the bankruptcy law put limits on cram downs of car loans; it will be interesting to see if Congress expands cram downs to mortgage loans will they also change the rule that apply to automobile debt.

Opponents to this expansion of cram down authority contend that by giving bankruptcy judges the power to change mortgage loan terms, the mortgage security market will be destablilized and that the cost and availability of mortgages – especially to credit challenged homeowners – will tighten because of the uncertainty that such potential modifications will bring to the market. [Read more…]

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