Chapter 13 bankruptcy offers consumer borrowers two powerful instruments for restructuring secured debt; lien stripping and cram-down.
Lien stripping is the process of removing a secured creditor when there is no value in the underlying asset securing the claim, as is often the case with junior lien holders. Such creditors would then be moved to the back of the line with the other unsecured creditors in the Chapter 13 plan, often only receiving pennies on the dollar.
Cram-down is really just another form of stripping where the claim is split into secured and unsecured portion, effectively "cramming down" the claim to the market value of the asset in a process known as bifurcation. The unsecured portion of the claim is stripped off and again treated the same as other unsecured debts, being assigned the lowest priority for repayment under the plan.
Given the precipitous fall in housing prices and the on-going foreclosure crisis it would seem these provisions were a godsend custom made for the troubled home owner, right? Were it only the case. The legislature, in its infinite wisdom, saw fit to exempt the borrower's homestead from these provisions. The purported rationale is that to do otherwise would discourage capital investment in the housing market. Ironically, you are permitted to use these provisions on a second home or a yacht, but if you want to save your house from foreclosure you are out of luck because allowing you to restructure your debt and stay in your home has been deemed to be too discouraging to mortgage lenders.
Instead you can declare Chapter 7, which most troubled home owners qualify for, and they will get nothing. The logic is impeccable, but I digress. The point of this article is that there is a silver lining.
In Minnesota, it is still possible to strip a junior lien on your residence. This is thanks to an entirely different part of the Bankruptcy Code governing the classification of a claim. It provides, in its pertinent part, that any claim secured by a lien on property is only a secured claim to the extent that it secured by value in the underlying property. What this means is that any lien which is wholly unsecured, think second mortgage on an underwater home, is not a secured claim by definition.
The Bankruptcy Appellate Panel for the 8th Circuit has recently ruled that when this is the case, the anti-modification provisions that exempt homesteads from lien stripping do not apply. If you have a wholly unsecured lien you may strip it off in a Chapter 13 bankruptcy and treat it as an unsecured claim. So is Chapter 13 lean stripping the right option for you?
That depends, there are several caveats…
Home valuation is not an exact science. How do you find the value of your home; tax assessment, similar listings in your neighborhood, recent appraisal? If the amount of your primary mortgage is anywhere near the value of your home, expect a fight. All it takes is a small amount value for them to secure the lien. It may be necessary to get an appraisal before filing to back up the value you are claiming for your home.
There may be additional legal costs associated with an attempted lien strip. The holder of the junior lien will likely oppose confirmation of your Chapter 13 plan if there is enough money at stake. Any resulting litigation may not be covered by the original retainer you signed with your attorney and may result in hourly legal fees.
Finally, a borrower must have regular income that is sufficiently stable for the purposes of funding a Chapter 13 plan. The interpretation of what constitutes regular income is quite broad, however, borrowers who do not have sufficient income to pay ordinary living expenses have been held to lack the regular income to be eligible to file a Chapter 13. So if you find you are barely able to tread water you may want consider just going with Chapter 7 liquidation.