If you still owe much more on your house than what it’s worth, you may be able to “strip” a second or third mortgage off your title.
To Be More Precise…
If you want to follow up on your New Year’s resolution to improve your financial life, and IF your home is worth about the same or less than your first mortgage, AND if you have a second and/or third mortgage, you can meet that resolution by taking one crucial step.
This one step would save you lots of money immediately, and then do so every month for years to come. It would not only help your immediate and long-term cash flow, this step would in effect create wealth for you, by making your home worth closer than what you owe on it. This means that as your home’s value increased, you would be building equity in it many years sooner than you would otherwise. In the long run, this step would likely save you many tens of thousands of dollars.
To Be Really Precise…
We’ll show how this works with an example, and then explain it a little more afterwards.
Consider a house that 6 years ago was worth $285,000, is now worth $200,000, with a first mortgage of $210,000, and a second mortgage of $50,000. Assume further that the monthly payment on the first mortgage is $1,500 and on the second mortgage is $350. The homeowners have fallen behind by 10 payments on both mortgages, so are behind $15,000 and $3,500, respectively.
Assume as well that the homeowners owe $5,000 in last year’s income taxes, and $40,000 in all other unsecured debts including credit cards and personal loans. The homeowners have steady income which would enable them to pay a total of $2,000 per month to all of their creditors, or $500 beyond the regular first mortgage payments of $1,500. This $500 per month would pay the $350 second mortgage payment but leave only a measly $150 per month for everything else—for catching up on the mortgages, and for paying the $5,000 in income taxes and the $40,000 in other unsecured debts. This is clearly not a sustainable situation. These homeowners are about to lose their home.
But a Chapter 13 filing would solve this seemingly impossible set of problems, on both a short-term and long-term basis. Because the house is currently worth less than the balance of the first mortgage ($200,000 vs. $210,000), the $50,000 second mortgage can be “stripped” from the home’s title. (Note that a Chapter 7 “straight bankruptcy” does NOT provide this huge benefit.)
The homeowners would resume making their first mortgage payment, but not their second mortgage one. The remaining $500 per month would be paid into their Chapter 13 plan for 5 years (the length of their plan being based on their income), for a total of $30,000 ($500 times 60 months). That $30,000 would go to pay the $15,000 in first mortgage arrearage and the $5,000 in income taxes, leaving $10,000. That would be divided among the pool of remaining debt totaling $90,000, the second mortgage balance of $50,000 plus the $40,000 in “general unsecured” debts, paying about 1/9th or about 11% of that $90,000. (These calculations exclude trustee and attorney fees for the sake of simplicity.)
The result is that these homeowners would pay (besides the payments on their first mortgage) a total of $30,000, instead of what they would otherwise have to pay $110,000 ($15,000 first mortgage arrearage + $5,000 income tax + $50,000 second mortgage + $40,000 “general unsecured” debts). This is a savings of $80,000.
The actual savings would be much more because the above doesn’t account for all the interest that would have to be paid on the second mortgage if it were not “stripped.” The true amount would depend on how long the homeowners would stay in the house. Interest makes up a large amount of what is paid on a mortgage, the exact amount depending of course on the interest rate and length of the loan. Just by way of example, a $50,000 second mortgage at 6% interest and $350 payments would take about 21 years to pay off, accruing nearly $38,000 in interest.
So instead of these homeowners likely losing their home, after five years in a Chapter 13 case they would be current on their first mortgage, would have paid off their income taxes, would no longer owe a dime on their second mortgage and would be debt-free except their first mortgage. This is quite a nice reward for following through on their New Year’s resolution to see a bankruptcy attorney!
To Summarize, “Stripping” the Second Mortgage Means…
- You would not have to pay the monthly payments on the second mortgage starting immediately after your Chapter 13 case is filed.
- If you were behind on the second mortgage, you would never have to catch up on it.
- The entire second mortgage balance would be treated as a “general unsecured” debt—just like your unsecured credit cards, medical bills, and other miscellaneous debts—meaning it would be paid only as much as your budget would allow within the 3 to 5 years that your Chapter 13 case is open, often only pennies on the dollar.
- Other important debts— such as your vehicle, first mortgage arrears, child and spousal support arrears, and recent income tax debts—take priority over your second mortgage debt, a portion of which would therefore be paid only after paying these higher priority debts in full.
- After your 3-to-5-year case is completed, however much you have not paid of the second mortgage balance (usually a large majority of that balance) would be discharged (forever legally written off).
- The lien on your home’s title that is tied to your second mortgage would be permanently removed.
- BOTTOM LINE: You’d likely save many tens of thousands of dollars and end up with a home much less under financial water.