Banks may fight back when second mortgages are wiped clean in bankruptcy

Despite the recent housing market rebound, home prices in New Jersey are still roughly 23 percent below where they were in 2006 when the housing market was at its peak, according to a recent report by the Star-Ledger. Sadly, with prices below 2006 levels, many homeowners who bought at the peak of the market are still underwater on their mortgages - meaning that the amount of their mortgages are greater than their homes' value.

In fact, a recent report issued by RealtyTrac found that roughly 250,000 New Jersey homeowners owe at least 25 percent more on their mortgage than what their home is currently worth - making them significantly underwater. Fortunately for these New Jersey homeowners, relief may be available if they elect to filing for bankruptcy, especially if they have second mortgages or home equity loans since these forms of debt can be stripped and eliminated during a New Jersey Chapter 13 bankruptcy.

However, these same homeowners need to be aware that it is likely that the second mortgage lenders will not simply stand by and let their money slip away - many lenders will put up a fight in order to protect their own interests.

Lien stripping in New Jersey

The process of eliminating second mortgages through Chapter 13 bankruptcies is more commonly known as "lien-stripping." Essentially, stripping second mortgages is possible for underwater homeowners because second mortgage lenders are no longer deemed secured creditors when the value of the home is insufficient to grant them any security interest. Consequently, second mortgage lenders are treated the same as all other unsecured creditors during a Chapter 13 bankruptcy - meaning they will receive the same pro-rata share as other unsecured creditors, which can be pennies on the dollar.

Obviously, lien stripping does not bode well for second mortgage lenders, which is why they may challenge any attempted elimination of second mortgages. For instance, lenders may make the argument that the home is actually worth much more than the individual filing for bankruptcy claims - in which case the lenders' property interests may not been wiped out. To back up these claims, second mortgage lenders may get their own professional appraisals of the properties in question.

This is why the valuation of property during bankruptcy can be so important. Accordingly, homeowners attempting the strip second mortgages through bankruptcy may want to consider having a professional appraise the value of their homes before the second mortgage lender has a chance to challenge the stripping. At the very least, if homeowners preemptively get appraisals they will have a valuation opinion ready to go should lenders elect the challenge the stripping of second mortgages.

It is important for homeowners to cover all of their bases if they are considering bankruptcy, which is why it is always a smart idea to also consult with a knowledgeable bankruptcy attorney before making any important decisions. A skilled attorney can assist with the filing process and help ensure all vital details are examined and properly addressed.