Our Florida clients sometimes ask me why they cannot strip off a second mortgage in a Chapter 7 like often done in a Chapter 13 bankruptcy nowadays. The limitation can be found in the United States Supreme Court’s decision in Dewsnup v. Timm, 502 U.S. 410, 417 (1992). The Court noted a distinction between the in rem and in personam claims created by a lien on a debtor’s property. The Court held that a Chapter 7 discharge of personal obligation leaves the in rem obligation intact against the property.
Even though a client might qualify to file a Chapter 7, sometimes the extra remedies available in a Chapter 13 make the more lengthy plan worthwhile. Under 11 U.S.C. 1322 a wholly unsecured second mortgage or HELOC can be stripped off a homestead. However, one other key difference exists between a Chapter 7 and 13. If a debtor retains a home in a Chapter 13, they are still personally liable for the first mortgage even if the second mortgage is stripped. Therefore, a Chapter 7 may still be best if the home is worth much less than the amount owed on a first mortgage and the debtor is uncertain about keeping the home long term.