Can a Second Mortgage Be Discharged in Chapter 13?

A second mortgage is a loan secured by your home, taken out in addition to your primary mortgage. When facing financial challenges, individuals with regular income may consider Chapter 13 bankruptcy, a reorganization process designed to help repay debts over a period of time. This legal framework allows debtors to create a repayment plan, often lasting several years, to manage their financial obligations.

Understanding Lien Stripping

A key concept in Chapter 13 bankruptcy that can affect second mortgages is “lien stripping.” This process allows for the reclassification of a secured debt to an unsecured debt under specific conditions. The primary condition for a second mortgage to be eligible for lien stripping is that the value of the property must be less than the outstanding balance of the first mortgage, rendering the second mortgage wholly unsecured.

For example, if a home is valued at $200,000, and the first mortgage has an outstanding balance of $250,000, any second mortgage on that property, regardless of its balance, is considered wholly unsecured. This is because there is no remaining equity in the home to secure the second loan after accounting for the first mortgage. In such a scenario, the second mortgage lien can be “stripped” or reclassified. This reclassification transforms the second mortgage from a secured debt, typically tied to the property, into an unsecured debt, similar to credit card debt or medical bills.

How Stripped Debt is Handled

Once a second mortgage debt has been stripped, it is treated as an unsecured debt within the Chapter 13 repayment plan. Like other unsecured obligations, such as credit card balances or medical expenses, this reclassified debt is included in the debtor’s overall repayment strategy. The amount paid to unsecured creditors, including the stripped second mortgage, is determined by the debtor’s disposable income and the terms of the Chapter 13 plan. This often means that only a fraction of the unsecured debt is repaid over the plan’s duration, and in some instances, no payment is made to these debts.

Chapter 13 repayment plans typically last between three and five years. If the debtor’s current monthly income is below the state median, the plan usually lasts three years; if it is above, the plan generally extends for five years. Upon the successful completion of all payments required by the Chapter 13 plan, any remaining balance of the stripped, unsecured second mortgage debt is legally discharged.

First Mortgage and Property Considerations

Unlike a second mortgage that may be stripped, the first mortgage typically retains its secured status and is generally not affected by the lien stripping process in Chapter 13. Debtors must continue to make regular payments on their first mortgage either directly or through the Chapter 13 plan to maintain ownership of their home and avoid foreclosure. This allows individuals to keep their property, provided they adhere to the terms of the repayment plan and remain current on their first mortgage.

Should the first mortgage be in arrears, Chapter 13 offers a mechanism to address these past-due payments. The debtor can include the mortgage arrears in the repayment plan, allowing them to catch up on these amounts over the three- to five-year period of the plan. This provision helps debtors avoid foreclosure.