Kentucky Bankruptcy Law

Counsel with Care

Saving One’s Home: What can be done with junior liens?

Many people who own a home have more than one loan secured against their residence. These junior liens (a consensual lien against real property is also called a mortgage) may be home equity lines of credit, business loans where the lender insisted on a personal residence as security, judgment liens, and so on. Judgment liens can be “stripped off” (the security interest ended) in either a Chapter 7 or Chapter 13 if it cuts into the debtor’s exemption. 11 USC Sect 522(f)(A). However, voluntary liens (one the debtor consented to) are more challenging.

The Sixth Circuit Court of Appeals made clear that voluntary security interests against real estate in this neck of the woods (including Kentucky) cannot be stripped off in a Chapter 7. In re Talbert, 344 F.3d 555 (6th. Cir. 2003). They stuck with the pre-code rule that “real property liens emerge from bankruptcy unaffected.” Id. at 561. This case focused on the role of 11 USC Sect. 506 which provides for the determination of a secured debt status.

So, if the only way to save your home is to get rid of (strip off) a second or third mortgage, you must file a Chapter 13 bankruptcy. However, the relief provided in a 13 is limited as well. If the loan is secured solely against the debtor’s real property which is also their principal residence, then the loan cannot be modified. 11 USC Sect. 1322(b)(2). The one exception to that takes us back to 11 USC Sect. 506: If the loan is completely underwater – that is, if there is zero equity in the property for the security interest to attach to (and I mean not even $1), then even such a loan can be stripped off and treated as wholly unsecured debt in the Chapter 13. When home prices were dropping consistently, this was a more common occurrence but it still happens.

What can be done with junior loans where there is some equity to which their lien attached? Well, this is where your bankruptcy attorney needs to take a careful look at the promissory notes, mortgages, and secured property. In an interesting case coming out of Ohio, the Sixth Circuit took a look at the meaning of the words “only”, “real property” and “principal residence” and found that they all three must come together for the 1322 protection to come into play. The In re Reinhardt, 563 F.3d 558 (6th. Cir. 2009) case involved a loan secured against a mobile home and the real property upon which it sat. Most would see that as real property which is the principal residence, but under Ohio law, the mobile home was personal property. Just like in Kentucky, that mobile home only became real property (affixed thereto) when the title was surrendered and the proper documents filed with the County Clerk.

Because the Reinhardt’s never surrendered the title of the mobile home, the loan was secured BOTH in the real property and an item of personal property. Therefore, the terms of the loan could be modified by the Chapter 13 plan. Basically, this means that the loan could be valued under 11 USC Sect. 506 and split into a secured claim and an unsecured claim. The part that was secured (equal to the value of the property at the time of the filing) would be paid in full (not necessarily in the plan though) and the rest would be paid pro-rata as with all the other unsecured debts. The other place where it is common for a loan to be secured against both one’s principal residence real estate and other property is with business loans. These lenders often want security in the home and in any assets of the business. However, this makes those loans vulnerable to modification (cram down).

Be sure that you bankruptcy attorney takes a careful look at all the factors that come into whether a secured debt with a lien against your home can be stripped off or crammed down.

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February 13, 2013 - Posted by | Bankruptcy, Chapter 13, Chapter 7, Exemptions, Foreclosure, Home loan modifications, Plan, Plan payments, Planning, PMSI (purchase money), Pre-filing planning, Property (exempt, Secured loan arrears, Security interests, The estate | , , , , , , , , , , , , , , ,

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