Joining the majority of courts that have addressed the issue, the Court of Appeals for the Fourth Circuit has affirmed the decision of the Bankruptcy Court and the U.S. District Court for the District of Maryland, allowing a Debtor in bankruptcy to remove a wholly unsecured second mortgage as a lien against their primary residence. Suntrust Bank v. Millard (In re Millard), 2010 WL 5158561 (4th Cir. 2010), aff’g, 414 B.R. 73 (D. Md. 2009).
In 2005, the Millards purchased their primary residence for $695,000. As was the typical practice at the time, the mortgage company financed 100% of the purchase price through an 80% first mortgage and a 20% second mortgage in the amounts of $556,750 and $138,250, respectively. Subsequently, the Millards refinanced the second mortgage twice, which resulted in a $280,000 line of credit with Suntrust bank.
The Millards eventually fell behind on both of their mortgage payments, causing them to file for relief under Chapter 13 of the Bankruptcy Code in June of 2008. At the time of filing, the Millards owed the first mortgage company nearly $621,000.00, which included additional fees and interest. The Bankruptcy Court held that the fair market value of their primary residence had declined substantially from the initial purchase price and was currently worth approximately $599,000. In the Chapter 13, the Millards sought to “strip off” (remove as lien against the property) the entire line of credit to Suntrust because it was wholly unsecured. Suntrust objected.
Suntrust’s position was that 11 U.S.C. § 1322(b)(2), known as the “anti-modification” provision of the Bankruptcy Code, prohibited the modification of any lien secured by a debtor’s primary residence. Specifically, the Code states that a Chapter 13 Plan “may . . . modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence . . .”
In analyzing Suntrust’s position, the Court looked to § 506(a) of the Bankruptcy Code, which defines a secured claim. The Court explained that under § 506(a) a claim is “secured” only up to the value of the property; to the extent the claim exceeds the value of the property, it is an unsecured claim.
Based on the Court’s reading of §506(a), the Millards’ first mortgage ($621,000) was greater than the current value ($599,000) of the property making the second mortgage wholly unsecured. Because the second mortgage did not meet the definition of a secured claim, the anti-modification provision is inapplicable. Suntrust’s mortgage was removed as a lien against the Millards’ property and treated as a general unsecured creditor (i.e. credit card or personal loan).
Therefore, a debtor in a Chapter 13 Bankruptcy may be able to completely remove a second mortgage against their primary residence where the first mortgage exceeds the fair market value of the property. Given the substantial decline in home values, this is an effective tool to help keep financially distressed homeowners in their primary residence.