As a bankruptcy law practitioner, I had been asked this question many times: what happens to your second or third mortgages and liens on your home when you file bankruptcy? Excellent question. Even though the law and practices are different, we still like to address these issues, basically from the perspective of Nevada standards only. As I had written earlier, the exemptions are state specific and controlled by State laws and not by the federal exemptions standards in Nevada. By state specific means, the exemptions are controlled under State laws of Nevada because that is how Nevada had chosen this entitlement. Well, if you play your cards right, maybe you don’t have to pay anything back to your lenders. Of course, your primary home is deeply submerged under water (unfortunately, and no light is visible at the end of the tunnel), so you need to make smart moves. First and foremost, it is advisable to have a homestead protection filing with the respective counties in Nevada. In Nevada, the homestead value for a single home is $550,000. The homestead is a simple process and cost very little probably less than $20. Why would you risk your home for this small amount?
The Real Estate Crash Has Resulted in Many Unsecured Second and Third Mortgages:
We know Nevada has been, unfortunately, number one state (we are tired of this top priority now) when it comes to foreclosure for so many years, and we not losing this dishonorable distinction in near future too. There has been a real estate crash and despite the innumerable gurus telling us (they always tell us something) that the bottom has reached, the prices of homes are still going down rapidly. The real estate boom also as a collateral effect resulting in many layers of lien of second trust and in some cases third lien on homes. The prices of homes were so high that without including second and third lien, many could not have bought these pricy homes. This is how your brokers softened the approach to give you a fast pitch. They also pose a problem in short sale as the second lien holder invariable do not agree to short sale and principal lender cannot do short sale unless the junior interests agree with them.
What Happens to Those Mortgages if You File for Bankruptcy?
Well we had written before that in Chapter 7 bankruptcy, your bankruptcy discharge will eliminate your personal liability on the second mortgage but will not eliminate the lien.
In Chapter 13 bankruptcy, you can eliminate both your personal liability and the lien in a procedure called lien stripping. Let us reiterate this rule one more time. The basic lien stripping rule is: You can eliminate a lien that has no security in the home, but you can’t eliminate the lien if part of it is secured by the home’s value.
What if a Lien Remains on Your Home After Chapter 7 Bankruptcy?
There is no lien stripping in Chapter 7 but you discharge your financial obligation minus lien on the property. This lien cannot be discharged. However, this lien has no long-term financial implications. The Chapter 7 bankruptcy will discharge your personal liability for the second mortgage (meaning you can’t be sued for money owed on it and no judgment can be levied against you, or your wages can be garnished.). The net result is that the holder of the note cannot foreclose on your home. But there is a likelihood, that you may have more equity on your home some day, and the same lien holder can come back and institute a deficiency judgment against you. It all depends if he see enough value in your home. So, it is not a bad idea to include second lien in your Chapter 7 and not reaffirm it. It is your bankruptcy, and you are the beneficiary here. Let us help you play your cards rights. Afterall, the goal is to get you a smooth discharge.