Supreme Court to Determine Whether Second Mortgages Can Be Voided During Bankruptcies

Mallet, legal code and scales of justice

On Monday, Nov. 17, the U.S. Supreme Court agreed to hear two separate cases, the outcomes of which will likely determine whether or not a second mortgage on a home that has a mortgage balance higher than the house’s value, otherwise known as an “underwater” house, can be discharged during a Chapter 7 bankruptcy.

According to Reuters, both bankruptcy cases came from Florida and were brought to the Supreme Court by Bank of America Corporation. Florida was one of the states most affected by the recent crisis that hit the housing market, with many homeowners struggling to make payments on their mortgages.

David Caulkett and Edelmiro Toledo-Cardona, the homeowners in the two cases, both won their cases in the regional appeals court of their home state, Reuters reports.

The 11th U.S. Circuit Court of Appeals ruled in both cases that it is permissible for an individual to strip off, or void, a second mortgage during a Chapter 7 bankruptcy if the homeowner owes a debt to the lender that’s greater to the home’s value.

Bank of America, which holds the mortgages of both Caulkett and Toledo-Cardona, argues against the 11th U.S. Circuit Court of Appeals’ rulings because the bank would lose its ability to foreclose on a property if a second mortgage is voided during a bankruptcy. The bank states that the appeals court’s ruling, if maintained by the rest of the country, could have an impact on thousands of cases currently pending.

“At the current time, the only way to strip a second mortgage off a home was in a chapter 13, this is one of the reasons why we sometimes recommend filing chapter 13. If the same thing could be done in a chapter 7, it would be a tremendous benefit for the debtors,” says Charles Huber of The Law Office of Charles Huber. “They could strip off a totally unsecured second mortgage without the extra expense and complexity involved when filing a chapter 13. To allow this practice would be a major change in the practice of consumer bankruptcy, and a departure from prior holdings of the Supreme Court, so I am skeptical that that it will be allowed.”

The Supreme Court’s final ruling on the cases won’t be due until June of next year — meaning it will be quite a while until a definitive answer to this question arrives.

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