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Lienstripping stripped down: a Q & A on the U.S. Supreme's recent decision

The housing crisis that came along with (and partly triggered) the Great Recession pushed the value of millions of homes underwater. This can caused all sorts of problems for homeowners.

In recent years, however, homeowners in the Cincinnati area with a second mortgage on their house have been able to get rid of second mortgage under certain circumstances . If you file a Chapter 13 bankruptcy and owe more on your first mortgage than the home is worth, it may be possible to get rid of - i.e., strip off - the lien on your second mortgage.

But what about Chapter 7 bankruptcy? Is lien stripping available there as well?

In this post, we will inform you about the U.S. Supreme Court's recent decision on this issue.

Why does the form of bankruptcy matter?

The two main types of consumer bankruptcy, Chapter 7 and Chapter 13, have somewhat different features.

Chapter 7 allows you to discharge more unsecured debt than Chapter 13. About two-thirds of the approximately 1 million people who filed bankruptcy in 2014 used this form.

But not everyone is eligible for Chapter 7. If you have sufficient income, your path to debt relief may involve a payment plan under Chapter 13.

What is "lien stripping" anyway?

Lien stripping refers to extinguishing or "cramming down" a junior lien so that it becomes unsecured debt.

It is not specific to second mortgages. But lien stripping for second mortgages is the particular focus of this post.

What have the courts said about lien stripping in Chapter 13 bankruptcy?

In a 2002 case, the U.S. Court of Appeals for the Sixth Circuit (which includes Ohio) held that a second mortgage on the principal residence of a debtor can be stripped off when the first mortgage is underwater.

The court reasoned that the claim represented by such a mortgage is worthless because the amount of the prior mortgage was greater than the actual value of the property.

If your home is above water, can you keep it when filing bankruptcy?

Like most states, Oho has a homestead exemption. The amount is $132,000 for singles or $264,000 for spouses. For more information, see our March 28 post.

What did last week's Supreme Court ruling say about lien stripping in Chapter 7 cases?

In a unanimous ruling, the Court said that lien stripping can't be used in Chapter 7 bankruptcy filings.

For now, this still leaves Chapter 13 as a possibility. But it is possible that the U.S. Supreme Court will reconsider that in the future. The Court hinted as much in its opinion.

Who won and who lost?

The Supreme Court's ruling last week is a win for the banking industry. Banks can now go after homeowners on second mortgages, even when Chapter 7 bankruptcy has been filed and the first mortgage is underwater.

This does not mean, however, that debtors are without other options, such as Chapter 13. It makes sense to talk with a knowledgeable bankruptcy attorney about what is best for your specific situation.

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