Chapter 13, Consensual 2nd Mortgage CRAMDOWN on primary residence.

[HHM]

I apologize in advance because this post will get a little technical.

http://www.cob.uscourts.gov/opinions/09-35891opinion.pdf

You read that right, cram-down on 2nd mortgage. Interesting new (revised) strategy emerging for dealing with 2nd mortgages on primary residence. Since the housing bubble, any regular reader of this forum has come across the idea of the 2nd mortgage lien strip.

In chapter 13 bankruptcy, you are allowed to remove (strip) the 2nd mortgage from your home if the home is worth less than what is owed on the first mortgage (or other superior liens). However, that option is all or nothing. There cannot be so much as one dollar of value in the home that covers the 2nd mortgage. So, if you owe $135,000 on your first mortgage and $40,000 on your second; if the home is worth $136,000, the ENTIRE 2nd mortgage stays and you are stuck with it. This is because of BK code section 1322(b)(2). That section does not allow the "modification" of the terms of a mortgage secured by the debtors primary residence.

In the last 9 months or so, the 2nd mortgage holders have started objecting to 2nd mortgage lien strips more often (probably as a result of heavy loses and with the temporary stabilization of home prices, they think they can argue for higher values) In chapter 13, the debtor files a 506 motion to value the lien of the 2nd mortgage at $0. 2nd mortgage lender objects saying the house is worth more.

1322(b)(2) says nothing about whether the debtor and 2nd mortgage can consensually agree to a cram down. A Cram down is where you reduce the principal amount owed on a secured debt to the market value of the underlying item. For example, if you owe $135,000 on your 1st mortgage, and $40,000 on your 2nd mortgage, and the home is worth $145,000. the "value" of that 2nd mortgage lien is only $10,000. 1322(b)(2) prevents the debtor from forcibly cramming down the 2nd mortgage, but (based on the case linked above) nothing prevents the debtor and 2nd mortgage holder from agreeing to cram down. Both sides face a huge risk in going to a hearing the before the BK judge , if the debtor wins, the 2nd mortgage gets nothing. If the creditor wins, the debtor is stuck with a 2nd mortgage. This strategy is particularly effective if the debtor is able or willing to convert to 7 and allow the home to foreclose, in which case the 2nd mortgage gets nothing. Thus, in borderline valuation cases, both sides have incentive to reach an agreement.

Note, this result is still a negotiation between debtor and 2nd mortgage, but think of it like a settlement of the second mortgage and allowing you to pay it off over time, the 36-60 months of the chapter 13 payment plan. In many scenario, this strategy may be preferable to the chapter 7 and negotiating a settlement after the BK, especially if the debtor does not qualify for chapter 7. In short, its a good strategy where the value of the house is on the border for 2nd mortgage lien strip.

These are the type of results you can get with a good, creative attorney. Most BK attorneys would never have thought of it.

[car67]

Excellent strategy and much needed to address the issue of people needing to cram down a 2nd! Awesome the banks are finally getting what they deserve.. Thanks for this info.

[despritfreya]

HHM,

In response to:

" You read that right, cram-down on 2nd mortgage. Interesting new (revised) strategy emerging for dealing with 2nd mortgages on primary residence. Since the housing bubble, any regular reader of this forum has come across the idea of the 2nd mortgage lien strip. . . These are the type of results you can get with a good, creative attorney. Most BK attorneys would never have thought of it."

Sorry, but I take offense to the above.

I (and many of my colleagues) have been negotiating with junior lien holders in both Chapter 13's and 11's for years. This “creative approach”, which is neither creative or new, has nothing to do with the boom and then bust of the market.

Many attorneys try to negotiate based upon the reality of the situation. These types of workouts are typically done with SBA loans, but also work with credit unions as well as other institutional lenders. While the debtor may have no right, under bk law, to change the terms of the loan, the parties most certainly can mutually agree to a reduction in the principal and interest rate and re-amortize the loan over what ever period they want. That is freedom of contract.

The reason such modifications can be successful inside bk has nothing to do with the “creativity” of debtor’s counsel. It has to do with the fact that debtor’s counsel is working directly with the lender's attorney, not some overworked and under paid customer service representative, which, but for the bk, would be the person one deals with.

This so called "strategy" while not always successful, will continue to be utilized as such benefits both the borrower and the lender alike. So long as the negotiators have the ears of their respective clients, deals can and will be made.

Des.

[HHM]

I am not sure why you would take offense. I did mention the (revised) strategy. However, this is one of the few published opinions on this specific issue because the chapter 13 trustee actually objected (which is baffling in its own regard, but that is a different issue). I grant that the idea of reaching consensual resolutions to these issues is nothing new.

The thing is, many attorneys do present the lien strip as all or nothing and don't even really mention an alternative. Most attorneys don't even offer to do these types of negotiations, so in that sense, it really doesn't come up that much.

Don't read too much into the introductory paragraph, I am only trying to set the context for the benefit of the readers of this forum.