On May 10, 2013 the U.S. Court of Appeals for the Fourth Circuit ruled that a debtor can strip off (eliminate) second mortgages and other junior liens in a Chapter 20 bankruptcy under certain circumstances. (In re Davis, No. 12-1184 (May 10, 2013).)
This means that if you file a Chapter 13 bankruptcy soon after a Chapter 7 bankruptcy, you may be able to get rid of second mortgages, liens, and HELOCs in the bankruptcy (if you live in the Fourth Circuit — Maryland, North Carolina, South Carolina, Virginia, and West Virginia).
Here’s how this works.
What Is Lien Stripping?
In Chapter 13 bankruptcy, if you have a second mortgage, junior lien, or any mortgage or lien other than your first mortgage that is “wholly unsecured,” you can get rid of it. The amount of the mortgage or lien becomes part of your unsecured debt — which most people pay off through their Chapter 13 plan at a rate of pennies on the dollar.
“Wholly unsecured” means that your equity in your home, after subtracting the balance on your first mortgage, won’t cover any of the balance on the junior mortgage. Here’s an example: Your home is worth $400,000 and the unpaid balance on your first mortgage is $450,000. You have a second mortgage for $50,000. Because your home equity is not enough to cover your first mortgage, your second mortgage is wholly unsecured, and eligible for lien stripping.
Lien stripping is allowed in Chapter 13 bankruptcy, but not in Chapter 7 (although you might be able to strip liens in Chapter 7 in the Eleventh Circuit.)
(Learn more about lien stripping in Chapter 13 bankruptcy.)
What Is a Chapter 20 Bankruptcy?
Chapter 20 bankruptcy is an informal way of referring to the practice of filing for Chapter 7 bankruptcy, and then following with a Chapter 13 bankruptcy. Some debtors do this because the Chapter 7 does not get rid of all their debts (for example, child support arrears, tax debts, and other priority debts). The Chapter 13 allows the debtor to pay off these debts in a three to five-year payment plan.
The debtor cannot get a discharge in Chapter 13 if it falls too close upon the heels of the Chapter 7 — but often that doesn’t matter. (Learn the rules about multiple bankruptcy filings.) The debtor can still get the protection of the bankruptcy court during the plan payment period, and in this way can make more reasonable payments towards the remaining debts.
Lien Stripping in Chapter 20 Bankruptcy
What remains an unresolved question in many circuits is this: Can a debtor strip off junior liens in a Chapter 13 bankruptcy even though there is no discharge available (because of the previous Chapter 7)?
The Court of Appeals in the Fourth Circuit, in In re Davis, No. 12-1184 (May 10, 2013) said yes. This is good news for bankruptcy debtors living in Maryland, North Carolina, South Carolina, Virginia, and West Virginia.