Foreclosure is a serious concern for many homeowners behind on their mortgage payments and at risk of default. This concern is even greater for people who took out home improvement loans or equity lines of credit and struggle to pay the bills on time. Although the real estate market in Kansas City has been improving since 2008, many people’s homes are still “underwater,” meaning the fair market value of the home is worth less than the primary mortgage.
Underwater homes where the owners took out secondary mortgages, home improvement loans or equity lines and who are facing foreclosure have opportunities to greatly improve their situations. Know that if your home is foreclosed upon and you do not file bankruptcy, you will still be responsible for the secondary loans, even if you no longer own the house.
The most beneficial path in such a situation may be to file Chapter 13 bankruptcy. In Chapter 13, there is an option for filers whose home is underwater to get rid of any junior secured loans completely. In Chapter 13, you can rid yourself of these junior loans (tax-free) by a process known as “lien stripping.”
How Bankruptcy Can Eliminate Home Improvement Loans
Let’s crunch some numbers to illustrate how a lien strip can work. If your mortgage principle is $200,000, but due to the real estate bubble bursting, the fair market value of your home was appraised at $175,000, then your house is “underwater.” Let’s also assume that before the real estate market crash, the home was appraised at $225,000 and you took out a $25,000 equity line for home improvements.
You now owe $200,000 for the primary mortgage and $25,000 for the equity line, but the home is only worth $175,000. If the primary mortgage holder forecloses on your home, it will sell the home for $175,000 (or less in a foreclosure sale, not to mention fees) and you will still owe $25,000 or more for the primary mortgage and $25,000 for the line of credit—but you won’t have the house.
This unfortunate situation can be avoided by filing Chapter 13 bankruptcy. If the homeowner files a Chapter 13 bankruptcy before the house is foreclosed upon, the homeowner’s financial position will improve drastically. In Chapter 13, you will have a budget and payment plan through the bankruptcy court with your income and family size in mind. If you have regular income, you will likely be able to save the home from foreclosure by continuing to make the primary mortgage payments as part of your Chapter 13 Plan.
However, in this situation, you may be eligible for a Chapter 13 lien strip. In bankruptcy, the $25,000 equity line discussed above would no longer be treated as a loan secured with an interest in the property. As an unsecured loan, it will be worked into the payment plan with the other unsecured creditors. So, if your Plan pays unsecured creditors zero cents on the dollar, 50 cents on the dollar or 10 cents on the dollar, the second mortgage holder will be treated similarly. When you have completed all the required payments in your plan, whatever remains of the $25,000 equity line will be discharged and you will no longer have a legal requirement to pay it. Further, you will not be taxed from the release of debt as income if the loan is discharged through bankruptcy.
Start Over Debt Free with a New Financial Life
Debt strikes indiscriminately. A home’s value can depreciate and finances can easily become unstable due to job loss or a medical emergency, leaving the debtor with no way to pay off home improvement loans or other liens. Our Kansas City bankruptcy lawyers understand that those filing for bankruptcy are seeking honest solutions to their problems. At The Sader Law Firm, we work one-on-one with clients and do everything possible to give them the best opportunity to start fresh. To talk to a bankruptcy lawyer at no charge, call our office today.