Many homeowners have found themselves with negative equity in their property. As such, they have made the decision not to pay their second mortgages or home equity loans. They do this with the expectation that the junior lien holder will not foreclose due to their status as a second position lien holder. Often these same people will file a bankruptcy case. When such a Debtor files a Chapter 13 case, the homeowner has the right to file a Motion with the Court and ask that the lien itself be classified as unsecured debt and that at the conclusion of their bankruptcy case, not only the debt be discharged, but that the lien that secures any interest the bank may have in the property be stripped or removed. When this happens, the junior lien holder has no right to foreclose down the road when the homeowner does not pay their second mortgage. However, the lien holder may challenge the Debtor’s motion in Court, and represent that the does have some equity to secure the junior lien. The key is that the Debtor must prove that if the property were to be sold at foreclosure there would be no money after paying the senior lien holder to pay the second mortgage.
When a junior lien holder’s rights change a bit though is when the Debtor files a Chapter 7 case. With a Chapter 7 discharge, a secured creditor can seek some limited recourse against the property, but not against the Debtor personally. After the bankruptcy discharge, the homeowner cannot be held personally responsible for any debt owed to the bank. They would have receive a fresh start under the bankruptcy. However, the lien against the property still remains intact, and the bank can foreclose. The risk though that the bank takes is that they must first pay the senior lien holder all the money they are owed before the junior lien holder can take anything.
In some situations though, a creditor may have already brought a law suit against the homeowner prior to filing the bankruptcy. Once the bankruptcy case is filed, the automatic stay stops any law suit for money debt against the Debtor. A foreclosure would be stopped as well pursuant to 11 U.S.C. s. 362(a). However, the Debtor must take certain steps to protect themselves and ensure everyone including the state court is aware of their bankruptcy filing and subsequent discharge order. The Debtor muse ensure both the court and the creditor’s attorney has a copy of the Notice of Bankruptcy (a legal notice called a suggestion of stay). Once the Debtor receives their Notice of Discharge, provide a copy of that too. This will ensure that a judgment against the Debtor is not inadvertently entered and more motions to vacate a judgment need be filed.
Finally, it should be noted that if the homeowner falls behind on their payments in a Chapter 13 case without stripping the lien, or in a Chapter 7 case, simply by being behind, the creditor may get permission of the court to go after the property while the case is active, by filing a Motion with the bankruptcy Court to lift the automatic stay. In these cases, you will need to consult with an experienced bankruptcy attorney to challenge such a Motion.