As a result of the collapse in the housing market, many homeowners are finding themselves with mortgages they are unable to repay. Loss of a job or a major change in financial circumstances has left many homeowners struggling to make ends meet. When coupled with the massive debt of credit cards or other loans, many turn to bankruptcy for relief from their financial problems.
While homeowners probably understand the concept of bankruptcy—a discharge of debt—many may not understand the specifics of the law including how it affects debtors’ first and second mortgages.
Discharging a First Mortgage in Georgia
Usually a first mortgage cannot be discharged in bankruptcy if debtors wish to remain in their home. If they file for bankruptcy protection, they must continue to pay the primary mortgage. However, they may be able to discharge their second mortgage.
Discharging a Second Mortgage in Georgia
Countless homeowners who purchased a home, particularly within the last five years, financed 80 percent of their home with a first mortgage and 20 percent of their home with a second mortgage.
If their home today is worth less than the appraisal value when they first purchased it and they have not built up equity to cover their mortgages, then homeowners can, in many cases, eliminate the second mortgage in bankruptcy. This is known as “stripping the lien.”
This can really be the ace in the hole for scores of homeowners—considering average home values have dropped 20-30 percent or more in some areas in Georgia.
Here is a closer look at how this may work for a typical homeowner. Let’s assume the following facts:
- A Georgia homeowner has a first mortgage of $350,000.
- A Georgia homeowner has a second mortgage of $50,000.
- A Georgia home has dropped to $300,000 in today’s real estate market.
Obviously, the Georgia home is now worth $100,000 less than the combined mortgages. However, if the hypothetical debtor wishes to continue living in the home, he or she can seek bankruptcy protection and petition the court to remove or “strip” the second mortgage. If granted, the debtor will no longer be required to make payments for the second mortgage.
And this is not just a hypothetical. MercuryNews.com recently featured a story about Bay Area homeowners and second mortgages and illustrated a real life example about a particular individual who succeeded in eliminating her second mortgage. The homeowner’s property dropped over $300k in value (less than the amount she owed in her first mortgage) and she still owed over 120k on her second mortgage. She sought Chapter 13 bankruptcy protection and after she completed the requirements, the trustee allowed her to discharge her second mortgage.
“I am finally able to see the light at the end of the tunnel and I’m so, so grateful,” she reported.
However, debtors wishing to strip a second mortgage are limited to filing only a Chapter 13 bankruptcy. This type of bankruptcy, as opposed to a Chapter 7 bankruptcy, involves consolidating debt and making a monthly payment over a 3-5 year period. Specifics of a Chapter 13 bankruptcy and its requirements are complex and debtors interested in learning how it applies to their specific situation should consult with a Chapter 13 Georgia bankruptcy attorney who can answer more specific questions.
Additionally, a certified appraiser will need to evaluate the house to make sure the current fair market value is in fact less than what is owed on the mortgages.
A Win for Homeowners
This small part of the bankruptcy laws are seemingly a win for the average homeowner. In the wake of the creditor-friendly change in the bankruptcy laws in 2005 that made it more difficult for debtors to seek Chapter 7 bankruptcy help, the predatory and fraudulent lending practices in recent years, and the previous taxpayer-funded bailouts of several multi-million dollar banks, the laws in this particular situation seem to be on the side of the average Joe.
For now, aside from petitioning Congress to once again change the bankruptcy laws to forbid homeowner from discharging second mortgages in bankruptcy, there isn’t much creditors can do.