11th Circuit Allows Mortgage Lien Stripping in Chapter 7 Cases

The 11th Circuit surprised the bankruptcy world recently when it ruled that Chapter 7 bankruptcy debtors could strip off wholly unsecured liens from their homes.  The ruling  represents a major victory for bankruptcy debtors — providing Chapter 7 debtors with a  powerful tool for debt relief.  Read on to learn what this new ruling means.

What Is Lien Stripping?

In most bankruptcy districts, lien stripping is allowed in Chapter 13 bankruptcy only. With lien stripping, if you have a second mortgage or junior lien on your home that is no longer secured by the equity in your home, you can strip it off (remove it). The stripped off lien becomes unsecured debt.

Here’s an example. Let’s say your home is currently worth $350,000. You have a first mortgage in the amount of $400,000, and a second mortgage in the amount of $50,000. The equity in your home does not cover the second mortgage (it covers $350,000 of the first mortgage). If you were to file for Chapter 13 bankruptcy, you could remove the entire second mortgage from your property.

For details on how lien stripping works, and for more examples, see the articles in Nolo’s Your Home & Mortgage in Chapter 13 Bankruptcy topic area.

The 11th Circuit Decision

In In Re McNeal, Case No. 11-11352 (11th Cir., May 11, 2012), the 11th Circuit ruled that a  debtor could strip off a home lien in Chapter 7 bankruptcy if no part of the lien is secured by the home’s equity (this is referred to as being “wholly unsecured”). It distinguished this situation from that discussed in the U.S. Supreme Court’s decision in Dewsnup v. Timm, which said you cannot strip off a partially unsecured lien in Chapter 7 bankruptcy. (For more discussion of the 11th Circuit decision as it relates to Dewsnup, see Carmen Dellutri’s post in the Bankruptcy Law Network forum.)

Good News for Bankruptcy Filers

This is good news for debtors living in the 11th Circuit’s jurisdiction. If you have a mortgage or lien on your home that is wholly unsecured (and in this day and age of plummeting real estate values, many people do), you can enjoy the many advantages of Chapter 7  bankruptcy and still be able to strip off the junior lien. Once the lien is stripped off, it will become unsecured debt and be discharged at the end of your Chapter 7 bankruptcy.

What Happens Next?

It’s almost certain that the 11th Circuit decision will be appealed to the U.S. Supreme Court. But in the meantime, Chapter 7 debtors can use this newly available tool in Chapter 7 bankruptcy.