Recently, a seldom-used bankruptcy technique has taken on new life. The technique is called “lien stripping” and it arises from Bankruptcy Code Section 506(a) and (d). A lien strip allows a Chapter 13 debtor to use the power of the Bankruptcy Court to transform a secured second mortgage or home equity line of credit into an unsecured debt, thereby eliminating a monthly payment and reducing total debt by tens of thousands of dollars.

Not surprisingly, the main issue that arises has to do with the fair market value of the home. An appraisal from Appraisals By Michael can convince the judge that the second mortgage is, in fact, fully unsecured.

Let’s say that you own a home worth $250,000. Perhaps that home was once worth $350,000, but its market value has dropped because of the recession. The balance on the first mortgage is $270,000 and the balance on the second mortgage is $45,000.

In this case, a Chapter 13 debtor can ask his bankruptcy judge to “strip away” the second mortgage debt since all of the value in your home is encumbered by your first mortgage. In other words, if you were to sell your house, the first mortgage lender would not be paid in full and the second mortgage lender would get nothing. The second mortgage lender is, therefore, unsecured.

Lien stripping only works when:

• you are a debtor in a Chapter 13 case
• the fair market value of your house is less than the balance due on your first mortgage

The Clerk’s Office of the Northern District of Georgia has provided us with sample lien stripping motions, which you can review by clicking on the link.

Most bankruptcy judges will allow lien stripping, and if your second mortgage or HELOC is fully unsecured, you may want to consider it as well. Lien stripping is perhaps the most reliable tool in modifying a mortgage.