Surrendering a Home with a Second Mortgage During Chapter 13

Recently on a bankruptcy forum website, a Chapter 13 bankruptcy filer wanted to know how the second mortgage would be handled in the plan. Her question was, “Will the second mortgage be turned into an unsecured loan that I have to pay off through my repayment plan or will it just be eliminated with the first mortgage?”

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Second Mortgage is Treated Differently than Primary Mortgage

In filing a Chapter 13 bankruptcy, debts are prioritized as to how the bankruptcy court trustee will make the payments within a plan. A second mortgage is treated differently than a primary mortgage note if the house is surrendered during the bankruptcy. Primary lenders receive priority payments before junior notes.

Secured debts are treated differently in a Chapter 13 bankruptcy than unsecured debts. If a Chapter 13 bankruptcy filer wants to keep an asset that is secured, they must keep up with the payments agreed upon by all notes of the secured asset during the plan. That means satisfying both primary and junior notes by making payments on time. Otherwise, the primary or secondary note holders can repossess or foreclose on the property for violation of their agreement if the owner defaults on the payments. If the owner of the note has filed for bankruptcy protection, the primary and/or secondary note holders must get the permission of the bankruptcy courts to process their security rights, or they must wait until the bankruptcy is concluded to do so.

If you want to surrender a secured asset during a Chapter 13 bankruptcy, you must tell the bankruptcy court of your intentions and then simply default on your secured contract. By defaulting on the secured notes, you are now placing the responsibility of collecting the debt onto the lenders. Their rights to collect are determined by contract and bankruptcy laws, both state and federal. Lenders must abide by state and federal laws or be prosecuted for their violation.

Second Mortgage Can be Stripped by Filing a Chapter 13 Bankruptcy

If your home is worth less than what you owe on the primary note, the secondary notes may be stripped of their liens and discharged in the bankruptcy as unsecured debt. Only under special circumstances will a second mortgage receive any type of payments during a Chapter 13 plan when you surrender your home. The secondary lien holders must file a claim with the court for payment of their debt and prove that there is a deficiency in the debt in order to be able to receive a payment during the plan. For most secondary loans underwater, this can be a very hard and tricky thing to do because they would have to foreclose on the home. Most are not willing to make this sacrifice or take this risk to collect on a secured debt that is underwater in its value.

In some rare cases, the homeowner is left with proving the value of the home is underwater if the secondary mortgage note holder files a claim to the bankruptcy court. Normally, an appraisal of the value of the home is enough to satisfy the court and prove whether a deficiency exists or not. This can all be done without putting the home up for actual auction, and secondary lenders prefer this type of method in determining value. It all depends on the bankruptcy district and what they will allow creditors to do and not do about such matters within their jurisdiction.

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