What happens to an underwater mortgage after a Chapter 7? That was the sorta metaphysical question my newbie luncheon partner asked at the NACBA workshops this fall.
She knew that you could not strip off a consensual lien in a Chapter 7. So, just what was the situation post discharge?
I really like questions 1) for which there is an answer, and 2) for which I know the answer. Or maybe it’s answers.
- The lien survives as a valid charge on the property.
- The lender’s exclusive remedy is foreclosing on the lien- no personal liability exists after bankruptcy.
Absent some other action, the lien may increase in value over time. The property may become more valuable, or the encumbrances ahead of the lien may be paid down. Interest continues to accrue on the underwater lien, so it grows if not paid.
The most likely end result is that any near term improvement in the property’s value will be sucked up by the lien. The debtor enjoys possession, but not increasing equity.
What do we tell our clients, then? Most obviously, file Chapter 13, where a consensual, unsecured lien can be voided, and the lien removed from title.
Next most desireable, try to negotiate the release of the lien by payment of some nominal sum. The lender is not likely to actually foreclose if foreclosure make it the owner of property subject to senior liens. The underwater lien holder is like the the proverbial dog in the manager: it can’t enjoy (doesn’t want) the house it’s sitting on, but won’t, without payment, remove itself. I’m told that settlements on loans secured only by underwater property are being settled at 3-15% of the loan balance.
The important thing for our clients is that the lien holder has only a lien of property of dubious value. Foreclosure or compromise won’t trigger any cancellation of debt income, because the debt was forgiven in the bankruptcy, regardless of how much time passes between discharge and action on the lien.
Image courtesy of FEMA and Jocelyn Augustino.