When Can You Strip Away A Second Mortgage In Bankruptcy?
New York law provides that judgments, as well as first and second mortgages, act as liens against real property. That means that once a judgment is filed against a client, it acts as a lien against their real estate, along with a mortgage or a Home Equity Line of Credit (“HELOC”) lien on the real estate. These act as secured debt which must be paid off when a party refinances or sells their home.
Under New York State law, a judgment lien can be “stripped away”, which means removed as a lien against the property and reduced to an unsecured debt, only if the first and/or second mortgages exceed the value of the home. Additionally, under New York State law, the “Homestead Exemption” of $50,000 per spouse takes priority over a judgment lien. Therefore, if a first and/or second mortgage, plus the Homestead Exemption exceed the value of the real estate, a judgment lien will be “stripped away”.
In order to strip away a judgment lien, a Motion must be brought in the County Court in which the judgment has been filed and the real estate exists.
In today’s real estate crisis, many homes are “underwater”. This means that the value of the home is less than the value of the first or second mortgage.
In Bankruptcy Court, it is quite common to strip away a judgment lien if it is unsecured by the value of the real estate. Stripping away a judgment lien in Bankruptcy Court means that the debt is turned into unsecured debt, which is either wholly discharged in a Chapter 7 bankruptcy, or paid off under a Chapter 13 bankruptcy for pennies on the dollar.
A second or third mortgage may likewise be stripped away in a bankruptcy proceeding if the amount of the second or third mortgage is “wholly unsecured” by the real property. The bankruptcy law in New York provides that, as long as a mortgage is 100% unsecured by the real estate, then it can be stripped away into an unsecured debt. That means that if the value of your client’s mortgage, plus the Homestead Exemption of $50,000 per spouse exceed the value of the real estate, then the second or third mortgage will be stripped away in a Chapter 13 bankruptcy.
Until recently a bankruptcy party was not allowed to strip away a second or third mortgage under a Chapter 7 bankruptcy. However, a recent case decided by Judge Eisenberg in the Eastern District of New York (Long Island), has held that a wholly unsecured second mortgage may be stripped down in a Chapter 7 bankruptcy.
However, if the second or third mortgage or judgment lien is even one percent secured by the value of the real estate, it cannot be stripped down into an unsecured debt.
The Bankruptcy Court judges in Westchester and the Hudson Valley (Southern District of New York) have not yet ruled on whether they will follow Judge Eisenberg in stripping down wholly unsecured mortgages in Chapter 7 cases. In fact, two Bankruptcy Court of Appeals cases have ruled against lien stripping in Chapter 7 cases.