Can I Eliminate My 2nd Mortgage Debt by Filing Bankruptcy?

Written by James Hirby | Fact checked by The Law Dictionary staff |  

If you're like most struggling homeowners, you took out your second mortgage with high hopes that it would improve your financial fortunes. After all, second mortgages are designed to provide some much-needed breathing room to folks grappling with rising interest rates on their existing obligations. Unfortunately, second mortgages taken out subsequent to the initial purchase of a home often confer little net benefit.

Second mortgages taken out in concert with first, or "primary," mortgages rarely help either. In fact, the net effect of most such loans is simply to grow their holders' already-onerous burdens of debt. Known as "80-20 mortgages," they gained notoriety during the housing bubble of the mid-2000s as a new means by which lenders could profit from anticipated increases in home values.

The smaller "second" mortgage loan in the 80-20 scheme typically carries a far higher rate of interest than the larger obligation. These rates are often designed to "balloon" after a defined grace period and become even more expensive. For boom-era borrowers who could barely afford their first mortgages, these sudden increases often put the monthly payments on their combined mortgages out of reach.

Fortunately, you may be able to avoid paying down your second mortgage by filing for Chapter 13 bankruptcy. Most bankruptcy courts consider second mortgages to be "junior" debts that can't be collected until all "senior" debts, including primary mortgage loans, have been settled. Since most people enter bankruptcy with few above-water assets and little in the way of liquid funds, junior creditors typically write off their debts as soon as the bankruptcy process begins. Although you'll lose your home to your primary mortgage lender, you probably won't be responsible for settling the second mortgage.

Under certain circumstances, it may be possible to eliminate your second mortgage and remain in your home. If your home's fair value has declined by more than the value of your entire second mortgage, your bankruptcy trustee may consider this debt to be "wholly unsecured." Even if you sell your home at a loss and use the proceeds to repay your primary mortgage lender, which still retains a secured interest in the property, you won't have any funds left over to cover your second mortgage. Accordingly, it may no longer have any legal connection to the tangible asset that it was used to purchase and may be treated as just another unsecured debt to be discharged in bankruptcy.

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