As home values continue to decline, more and more homeowners are finding that their houses are worth less than they owe on their mortgages. This negative equity is often referred to as being “upside down” or “underwater.” For some homeowners who have two mortgages, the home may be so underwater that the amount owed on the first mortgage alone is more than the value of the home. While extremely troubling for homeowners, this situation may be able to be fixed in the context of a Chapter 13 bankruptcy.
Usually, the bankruptcy law prohibits homeowners from modifying the terms of their home mortgages. But there is one important exception to this, , which is the scenario described above: where the value of the home is less than the amount owed on the first mortgage, leaving the second mortgage entirely unsecured by the value of the house. In this case, the bankruptcy law allows homeowners to file a Chapter 13 bankruptcy and void their second mortgage and potentially pay little to nothing to get rid of it.
Where a second mortgage is not secured by any equity, the bankruptcy law permits homeowners in Chapter 13 bankruptcy to separate the note from the security instrument (the second mortgage). The note may still have to be partially paid back, but the lender no longer has the right to enforce the mortgage or foreclose if you stop making payments. The result is actually in line with the economic realities of the situation because, even if the lender foreclosed upon the second mortgage, it would gain nothing from the sale proceeds because sale proceeds always go to the first mortgage first.
Homeowners may wonder how much they would have to pay back, and if it would be affordable. Depending on the homeowner’s income and assets, a person may propose a repayment plan where the lender receives much less than the full amount owed. In some instances, the homeowner in a Chapter 13 bankruptcy may be required to repay as little as 10% of the amount owed. For example, on a second mortgage worth $60,000, a homeowner may be able to get away with only paying $6,000. Upon completing the partial repayment plan, , the homeowner then receives a discharge on the remaining balance owed to the lender. The homeowner would also receive from the lender paperwork discharging the second mortgage that can be recorded in the registry of deeds.
In conclusion, if you have two mortgages, and if you owe more on your first mortgage than your house is worth, a Chapter 13 bankruptcy may allow you to eliminate your second mortgage completely.