When can you cancel a second mortgage in bankruptcy?
New York law provides that judgments, as well as first and second mortgages, act as liens on real estate. This means that once a judgment is filed against a customer, it acts as a lien on their real estate, along with a mortgage or home equity line of credit (“HELOC”). They act as secured debt that must be repaid when a party refinances or sells their home.
Under New York State law, a judgment lien can be “discharged,” meaning removed as a lien on the property and reduced to an unsecured debt, only if the first and/or second mortgages exceed the value of the home. Additionally, under New York State law, the $50,000 Homestead Tax Exemption per spouse takes precedence over a judgment lien. Therefore, if the first and/or second mortgages, plus the Homestead Exemption, exceed the value of the real estate, the judgment will be “set aside.”
To foreclose on a judgment lien, an application must be filed in the county court where the judgment was filed and the real property exists.
In today’s real estate crisis, many homes are “underwater.” This means that the value of the home is less than the value of the first or second mortgage.
It is quite common in bankruptcy court to foreclose on a judgment lien if it is not secured by the value of the real estate. A discharge in bankruptcy court means that the debt becomes an unsecured debt that is either discharged in full in a Chapter 7 bankruptcy or discharged in a Chapter 13 bankruptcy for pennies on the dollar.
A second or third mortgage can also be foreclosed in a bankruptcy proceeding if the amount of the second or third mortgage is “wholly unsecured” by the real estate. New York bankruptcy law provides that as long as the mortgage is 100% unsecured by the real estate, it can be discharged into unsecured debt. This means that if the value of your client’s mortgage plus the Homestead Exemption of $50,000 per spouse exceeds the value of the real estate, then the second or third mortgage will be foreclosed in a Chapter 13 bankruptcy.
Until recently, a party in bankruptcy was not allowed to foreclose on a second or third mortgage under Chapter 7 bankruptcy. However, a recent case decided by Judge Eisenberg in the Eastern District of New York (Long Island) held that a fully unsecured second mortgage can be discharged in a Chapter 7 bankruptcy.
However, if the second or third mortgage or judgment is secured by even one percent of the value of the real estate, it cannot be removed into unsecured debt.
Bankruptcy court judges in Westchester and Hudson Valley (Southern District of New York) have not yet ruled on whether they will follow Judge Eisenberg in striking down fully unsecured mortgages in Chapter 7 cases. In fact, two Bankruptcy Court cases are ruled against forfeiture in Chapter 7 cases.
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