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Lien stripping in bankruptcy

A core function of bankruptcy law is the "fresh start" that occurs with the clearing of debt from a individuals financial balance sheet. When you are so far behind on your bills, and there is a constant barrage of collection letters and phone calls, it can become psychologically taxing, in addition to economically demoralizing.

Chapter 7 and Chapter 13 provide the means to this fresh start. For homeowners who have suffered the fate of seeing their homes go underwater after the real estate bubble collapsed, one advantage a Chapter 13 has had is that it allows debtors to strip off second mortgages when they become completely unsecured due to the fall in the value of the home.

In most jurisdictions, this option has not been available to those who file Chapter 7 because of a Supreme Court case from the early 1990s. Recently, the Eleventh Circuit allowed a debtor from Florida to strip a second mortgage, which created a split among the circuits and has forced the Supreme Court to revisit the issue.

One debtor owed $231,119 on his home, which was only valued at $98,000. He owed $183,264 on the first mortgage, and $47,855 on the second mortgage. If the property were foreclosed, the proceeds of the sale, at best would only cover 50 percent of the first mortgage and nothing for the second mortgage.

Because Chapter 7s typically are completed within six months and are less expensive than a Chapter 13, this case is important. Chapter 13s requires a three to five year repayment plan, and many are frequently dismissed when the debtor suffers a loss of income during that period.

Lien stripping in a Chapter 7 should be allowed because to allow a lien to remain on a worthless loan gives the creditor a better outcome than what they would receive during a foreclosure, which is one standard used by bankruptcy courts to determine creditor treatment.

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