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How does a mortgage lien strip work in bankruptcy?

Mortgage lien stripping is available to consumers 'under water' in Chapter 13

Those who file a Chapter 13 petition with the U.S. Bankruptcy Court may use a powerful tool that allows them to remove a second mortgage from their homes.

With the housing crisis causing many home values to fall below the amount of their mortgages, this option is particularly helpful to people who are deep in debt, but have the income to make monthly creditor payments required in a Chapter 13 action.

The practice is called lien stripping, and for a consumer to qualify, the value of the house must be below the balance of the first mortgage. That leaves the second mortgage not backed by any equity in the home, which turns it into an unsecured loan similar to credit card and medical bills.

"Through a lien strip, the bankruptcy court essentially takes your second mortgage - a secured debt in which the lender can foreclose on your property if you miss your payments - and converts it to an unsecured debt by ordering the lender to remove its lien from the property," according to Nolo.com, a legal website.

Bankruptcy attorneys at Friedman Iverson, a Minneapolis law firm, advise debtors involved in a Chapter 13 bankruptcy to be sure of the value of their homes before embarking on a lien strip.

"You will most likely need to order an appraisal of your house. But the first step is to look at your property tax appraised value," states the law firm's website. "During the housing boom, tax values used to be lower than the true value of the house. But now that housing prices are depressed, property tax appraisals are routinely higher than the appraised value of the house."

Once the Chapter 13 repayment plan is completed, the second mortgage lien is removed permanently from the property. It is discharged along with other unsecured debts and creditors are prohibited from pursuing further collection efforts or lawsuits to recoup their loss.

A mortgage lien strip can be used on more than one "junior," or secondary, mortgage. If there are three liens on the home and the main mortgage is greater than the house's value, both the second and third mortgages can be stripped.

"However, if your house is worth more than your first mortgage alone but not more than the combined balance of your first and second mortgages, then you can only strip your third mortgage," states Nolo.com.

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