"Lien stripping" arises from Bankruptcy Code Section 506(a) and (d) and allows a Chapter 11 or 13 debtor to transform a secured second mortgage or home equity line of credit into an unsecured debt (like a credit card debt), thereby eliminating a monthly payment and reducing total debt by tens of thousands of dollars.
Here's how it works: let's say that you own a home worth $500,000. Perhaps that home was worth $850,000 three or four years ago but its market value has dropped because of the recession. The balance on the first mortgage is $550,000 and the balance on the second mortgage is $150,000
In this case, a Chapter 11 or 13 debtor can ask the bankruptcy judge to "strip away" the second mortgage lien since all of the value in your home is encumbered by your first mortgage. In other words, if you were to sell your house, the first mortgage lender would not be paid in full and the second mortgage lender would get nothing. The second mortgage lender is, therefore, unsecured.
Once "stripped away" a portion of the debt that used to be secured by the lien against the property is paid as if it were an unsecured debt. Depending on the circumstances of the case, this could be as little as $0.00.
In order to take advantage of a lien strip, these two elements must exist:
1. You must be a debtor in a Chapter 11 or Chapter 13 case, and
2. The fair market value of your house is less than the balance due on your first mortgage
Mark Brenner has successfully "stripped" several junior mortgages in Chapter 11 and 13 cases. In cases where the value is several thousand below the balance of the first loan, banks do not usually oppose the motion. In close cases there may be a dispute and the main issue that arises, not surprisingly, has to do with the fair market value of the home. In order to have the better evidence of value, it is recommended that you pay for an appraisal of your property to convince the judge that the second mortgage is, in fact, fully unsecured. However, in those cases where the value has dropped dramatically, it can be established by the opinion of a real estate broker or other real estate professional.