Mortgage modification in bankruptcy is a confusing topic. Some say you can. Some say you can’t. As with most bankruptcy issues, the answer is: “It depends.”
However, it’s clear that if you have a wholly unsecured mortgage, you can “strip off” or “value” the mortgage at zero.
Let me give you an example from a recent Summerville bankruptcy case I filed last week. The clients owed $270,000 on a first mortgage and $51,000 on a second mortgage on their residence. Under these circumstances, the law is clear: (1) the first mortgage cannot be modified since it’s a debt secured solely by a mortgage on the clients’ residence, and (2) the second, $51,000 mortgage, can be modified if the property is worth less than what’s owing on the first mortgage (in this case less than $271,000). Assuming that’s the case, the second mortgage is wholly unsecured. In foreclosure, the second mortgage holder would not receive anything. And, in turn, if that’s the case, the second mortgage can be stripped off in a Chapter 13 bankruptcy.
How does this work?
First, it only works in Chapter 13 bankruptcy, which is a payment plan bankruptcy. In Chapter 13 bankruptcy, the debtor could “value” the second mortgage at zero because the lender really has no security for the loan. (Remember, the property is worth only $260,000 and the first mortgage is $270,000–$10,000 over the value of the property.)
So the debtor’s plan would provide something like this:
C. Valuation of Security: The debtor moves, in accordance with 11 U.S.C. § 506, to establish the value of a lien as follows:
|Name of creditor and description of property securing lien||Value of Debtor’s interest in property||Holder and amount of superior liens||Estimate of creditor’s claim||Value of lien (see IV(B)(4) below)||Unsecured claim after valuation (see IV(E) below)|
|BAC Home Loans Servicing (Account # 12345 Second Mortgage)Real property commonly known as 123 Main Street, Summerville, SC||$260,000.00||BAC Home Loans Servicing (Account# 54321 First Mortgage)Amount: $271,000||$51,000||$0.00||$51,000|
Under the Bankruptcy Code, the lender is secured to the extent of the value in the collateral. That’s what section 506 of the Bankruptcy Code says, and that’s pretty logical. For example, if a lender uses a car as collateral for a loan, the lender is only secured up to the value of the car. So if the car is worth $10,000, that’s how secured the creditor is in the transaction. So, too, a lender who loans money on real estate and takes a junior mortgage position–2nd or 3rd mortgage–is only secured to the extent of equity to which the mortgage may attach. And in our example above, that’s nothing!
Proving values is very important
Knowing the value of the property–the collateral–in the case is obviously critically important. After all, if I’m wrong about how I valued the property so much that that second mortgage is secured–even partially–then the court will deny my motion to value the mortgage at zero–wholly unsecured. Here, if the home is worth $271,000, then that $51,000 second mortgage is not wholly unsecured. It’s what we call “undersecured.” Still, it’s secured rather than unsecured. For this reason, we had an appraisal done and are confident of our valuation. The home is in an established Summerville neighborhood with over fifty homes, so values are relatively easy to determine.
The 4th Circuit Court of Appeals recently upheld a debtor’s right to strip off a second mortgage
Just this past week the Fourth Circuit Court of Appeals (the appellate court below the U.S. Supreme Court for Maryland, Virginia, West Virginia, North Carolina and South Carolina) upheld a lower court decision allowing a second mortgage to be stripped off in a Chapter 13 plan. In that case, Suntrust Bank challenged a Maryland debtor’s right to strip off a second mortgage. The Bankruptcy Court allowed it, and the decision was affirmed by the District Court. SunTrust appealed to the Fourth Circuit, which summarily held:
SunTrust appeals the district court’s order affirming the bankruptcy court’s order granting the Debtors’ Motion to Avoid Lien. We have reviewed the record and find no reversible error. Accordingly, we affirm for the reasons stated by the district court. SunTrust Bank v. Millard, No. 8:08-cv-03002-MJG, 08-17964 (D. Md. Nov. 7, 2008 & Sept. 28, 2009).
So mortgage stripping in South Carolina is alive and well, provided the facts (valuation and loan balances) justify it. If you have a second mortgage and wish to keep your home, talk to a bankruptcy lawyer about your options. Given the fact that out-of-court modification has been an abysmal failure, the only real opportunity may be under the Bankruptcy Code.