Some struggling homeowners are using a little known, but increasingly popular, provision of the bankruptcy code to eliminate second mortgages and avoid foreclosure.
Bankruptcy laws prevent homeowners from eliminating the debt of a first mortgage if they plan to stay in their home. But second mortgages are treated differently. Second mortgages can be declared unsecured debt when there is no equity to cover them.
When that happens in a personal bankruptcy proceeding, the second mortgage is put on hold and no payments are required while the homeowner completes a repayment plan for other debts, which typically takes three to five years. At that point, the second mortgage is eliminated.
While this strategy has gained in popularity among homeowners, mortgage bankers are not in favor of the practice, and have called it “a troubling phenomenon.” However, there is little the mortgage industry can do, aside from seeking to change the law, which could be difficult given the current partisan lineup in Washington.
The law has been like this for years, bankruptcy lawyers say. It's just never been used as much because in the past there was usually enough equity in a home to cover the second mortgage.
Brette Evans, a San Jose bankruptcy lawyer says "We're having great results using the rule. In one recent case, a small-business owner was able to hang on to her home by setting aside a $240,000 second mortgage”, she said.
That put the borrower in "a safe zone" where she could work out a modification of her first mortgage.
(c) Patty Ross - KRXA Radio Show #207 - Aired May 20, 2011
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