Filing bankruptcy doesn’t just allow the “discharge” (legal write-off) of debts. Under certain circumstances it also enables a homeowner to get rid of certain kinds of liens against the home. This is quite unusual because most of the time the bankruptcy laws preserve a secured creditor’s rights in a debtor’s property. But under the right facts, judgment liens attached to a home can be erased, and so can some 2nd or 3rd mortgages. These liens and mortgages can more likely be erased if the home is worth less. So recent reductions in home values can make a huge difference.
Judgment Lien Avoidance:
A judgment lien usually attaches to the real estate of the owner of that real estate around the time of the entry of a money judgment against that owner. Depending on the particular facts and local law, that judgment lien gives the creditor the right to seize and sell the real estate to pay off the judgment.
Bankruptcy—either Chapter 7 or 13—provides a way to get rid of judgment liens, but only if the amount of equity in the home (before accounting for the judgment lien) is LESS than the homestead exemption. Basically, the homeowner gets to preserve equity up to the amount of the applicable homestead exemption, and to “avoid” any judgment lien which “impairs” (gets in the way of) that homestead exemption.
So, if the home fell in value, leaving equity no more than the homestead exemption amount, the homeowner would now be able to “avoid” the entire judgment lien.
“Stripping” 2nd Mortgages in Chapter 13:
In a Chapter 13 case, if there is no equity at all for the 2nd mortgage, then the homeowner can “strip off” the lien securing this mortgage against the home. Doing so turns this debt into an unsecured one. Then during the three-to-five year Chapter 13 case, either some, none, or all of that debt is paid pro rata along with the rest of the unsecured debt—usually only a small portion is paid. IF the Chapter 13 case is completed successfully, whatever is left unpaid on that debt is completely written off. So the debt is gone along with its lien, forever.
Reduced home value makes it more likely for a second mortgage to have no equity at all, which is what allows this lien “stripping.”