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Options For 2nd Mortgages After Bankruptcy

Categories: Avoid Liens, Chapter 7, Junior Mortgage

Here’s a question posted recently over at AVVO.com.:

“We had a Chapter 7 bankruptcy discharged two(2) years ago. We have a second mortgage that we haven’t paid on in 2.5 years that has a $95,000 balance. We have not had any communication with the lender. Would like to know what our options are and the repercussions that are in the future.”

Here are some options when there is a second mortgage lien lingering after discharge. CAVEAT:  I am only licensed in California and have just learned that laws vary by state.  Please contact a local attorney in your area for more details and perhaps even more options.  Find a local lawyer here.

It’s important to know that a bankruptcy discharge eliminates your legal obligation to pay debts owed.  When it comes to mortgages, there are two parts:  the mortgage debt, and a lien against the property.  What this means is that the mortgage debt is discharged, but the lien will survive, unless it has been avoided (“stripped”), or otherwise ordered by the court to be removed.

  • Negotiate The Removal of the Lien:  After bankruptcy we no longer consider the balance owed as the negotiation point, but rather, the price to get the lender to strip the lien because the debt is no longer owed.  That’s why the borrowers in this scenario have gotten away with not paying this second mortgage for more than two years after a bankruptcy discharge.  I’ve seen as much as 90% discount on these loans, regardless of how much equity the home has. The goods news here is that all debts discharged in bankruptcy incur NO TAXES.  So, you won’t have to pay taxes on this cancelled debt AFTER BANKRUPTCY.
  • File a Chapter 13 to Fully Remove the Lien:  If the value of your home is equal to or less than what you owe on the First Mortgage, then you can qualify to Avoid the Junior Lien (also known as a “Lien Strip”) in a Chapter 13 bankruptcy case.  You’ll treat the junior mortgage like any other unsecured creditor and make payments over five (5) years.  Once complete, the lien will be removed; whether you get a discharge or not.
  • Do Nothing and the Lien Will Be Paid Upon Sale of the Home:  The mortgage debt obligation may be gone, but the lien can sit there indefinitely until you either sell or refinance the house. So, if there is no money to negotiate and pay to have the lien remove, just leave it alone.  Call an attorney immediately, if you receive any legal notices regarding this mortgage, or, if the lender tries to foreclose.
  • Refinance:  Why would you pay full price to refinance a loan you’re not obligated to pay after discharge?  The answer lies in whether there are funds available to negotiate.  Can you tell I’m a big fan of negotiation?

I believe that making a well informed decision requires the gathering of all the facts and consulting with professionals to get the best possible outcome as economically possible.  In other words, I prefer the cheaper, better, faster way to get to a goal, but that usually comes after I have explored all options and potential outcomes.

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