The recent real estate crisis has left a shocking 6.4 million Americans underwater in their mortgages.  These millions of Americans remain upside down in their mortgages despite the national increase in home prices.  Across the U.S., there are over 48,988,792 outstanding mortgages.  Of these, 6,000,000 are considered negative equity mortgages, in which the homeowner owes more than the property is worth.  Another 1,548,082 are listed as having near negative equity.  This equates to 13% of all American homeowners having an underwater mortgage, and 3.2% barely maintaining equity.  In Arizona, the number of upside down homes exceeds the national average, with 22% of homeowners stuck in negative equity mortgages and another 3.8% are near negative equity.

            For the tens of thousands of Arizona residents trapped in upside down mortgages, Chapter 13 bankruptcy can offer significant relief.  Under Chapter 13 bankruptcy, not only can the debtor halt the looming foreclosure process, if any, but he or she may also be able to “strip” any second or junior mortgages from the property.  Often, underwater homeowners have more than one mortgage.  These junior or second mortgages are generally acquired for home improvement purposes, to pay down debt, or to start a new business venture.  In this lagging housing market, it is often the second, or even third, mortgage that causes the overall debt to exceed the value of the home.

            In Arizona, a debtor who has filed for Chapter 13 bankruptcy can actually initiate a suit during the bankruptcy process requesting the court modify the rights of the second lien holder.  Ordinarily, all mortgages are considered secured debts, giving the mortgage holder the right to take back the collateral property in the event the lien is defaulted on.  However, the Bankruptcy Code states that the second mortgage is only secured against the property when the value of the property exceeds the amount of the first mortgage.  For example, if a debtor has a home worth $150,000, a first mortgage for $155,000 and a second mortgage of $30,000, then the second mortgage can be declared unsecured.  The only requirement is that the value of the home be less than the first mortgage.  Upon petition by the Chapter 13 declarant, the bankruptcy court can strip the second mortgage, transforming it from secured debt to unsecured debt.  Some or all of this unsecured debt can then be discharged under a successful Chapter 13 bankruptcy. 

            A home appraisal will be the most important element to achieving the stripping of your second mortgage.  If you are considering filing for a Chapter 13 bankruptcy, obtain a full and complete appraisal before you file.  Current housing prices are erratic, and many homeowners lack a full understanding of their home’s value.  A home appraisal will cost some money up front, but the potential savings will make the expenditure well worth it.  With your appraisal in hand, your bankruptcy attorney can then begin the process of preparing for the request to strip the junior mortgage.    

            You should not expect the mortgage to be stripped automatically.  The second mortgage holder has much to lose if the court grants your request, so it will often contest the action.  The junior lien holder may request an independent appraisal, and the court will consider both appraisals.  Ultimately, the bankruptcy court will decide which appraisal to accept.