Removal of Second Mortgages in Chapter 7 Bankruptcy Cases

Previously, the general rule in bankruptcy was that if a homeowner wanted to “strip off” or remove a second mortgage, he or she could only do so in a Chapter 13 bankruptcy.  However, that has now changed. In McNeal v. GMAC Mortg., LLC (In re McNeal), 2012 U.S. App. LEXIS 9589 (11th Cir. 2012), the courts recently held  that a homeowner who files a Chapter 7 bankruptcy may now “strip off” or remove a second mortgage if the amount owed under the first mortgage exceeds the fair market value of the property (that is, when the property is wholly “under water”).  This opinion is of great importance to homeowners in Florida who may be considering a short sale, but may have been deterred by the fact that they have had to negotiate with multiple lenders. That is no longer the case.

Now, if a homeowner has a first mortgage that exceeds the property’s value (i.e., a traditional short sale candidate) and that homeowner qualifies for Chapter 7 bankruptcy relief, he/she will essentially be able to wipe out the lien of the second mortgage in bankruptcy, thus making it much easier to complete a short sale where there are two or more mortgages involved. The reason…upon the stripping off of the second mortgage in bankruptcy, the homeowner will not even need to negotiate the release of the second mortgage with that lender.  And more importantly, the debt owed to that second lender will be treated as unsecured debt, which is typically discharged at the end of the Chapter 7 bankruptcy. 

As always, if you have any questions about this matter, we strongly advise you to consult with an attorney.

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