When can you pay off a second mortgage in bankruptcy?

New York law provides for court judgments and first and second mortgages to function as a lien. This means that once a judgment is issued against a customer, it acts as a lien on their property, along with a mortgage or lien on the home equity line of credit (“HELOC”) on the property. These act as secured debt that must be repaid if one party refinances or sells their home.

Under New York state law, a lien can only be “stripped,” meaning it is removed as a lien on the property and reduced to an unsecured debt, if the first and/or second mortgage exceeds the home’s value. Additionally, under New York State law, the homestead exemption of $50,000 per spouse takes precedence over a lien. Therefore, if a first and/or second mortgage plus the homestead exemption exceeds the value of the property, a compulsory lien is “stripped”.

To remove a judgment lien, an application must be made in the district court where the judgment was filed and the property exists.

In today’s real estate crisis, many houses are “under water”. That means the home’s value is less than the value of the first or second mortgage.

It is quite common for the bankruptcy court to release a lien if it is not secured by the value of the property. Stripping a lien in bankruptcy court means the debt is converted into unsecured debt that is either settled in full in a Chapter 7 bankruptcy or repaid for pennies on the dollar in a Chapter 13 bankruptcy.

A second or third mortgage can also be canceled in bankruptcy proceedings if the amount of the second or third mortgage is “completely unsecured” by the property. New York bankruptcy law provides that as long as a mortgage is 100% unsecured by the property, it can be converted into an unsecured debt. This means that if the value of your customer’s mortgage plus the homestead exemption of $50,000 per spouse exceeds the value of the property, the second or third mortgage will be forfeited in a Chapter 13 bankruptcy.

Until recently, a bankrupt party was not permitted to eliminate a second or third mortgage in a Chapter 7 bankruptcy. However, a recent case decided by Judge Eisenberg in the Eastern District of New York (Long Island) found that a totally unsecured second mortgage can be eliminated in a Chapter 7 bankruptcy.

However, if the second or third mortgage or compulsory lien is secured by even one percent of the value of the property, it cannot be broken down into an unsecured debt.

Bankruptcy court judges in Westchester and the Hudson Valley (Southern District of New York) have not yet decided whether they will follow Judge Eisenberg in phasing out fully unsecured mortgages in Chapter 7 cases. In fact, two Bankruptcy Court of Appeals cases have ruled against the deduction of liens in Chapter 7 cases.