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In the News
Supreme Court to Review Second-Mortgage Bankruptcy Liens
By Katy Stech - Updated Nov. 17, 2014 6:48 p.m. ET With Loans Underwater, Second Lien Is Valueless, Homeowners Argue; Lenders Disagree
The country’s top court Monday agreed to hear arguments on whether homeowners can cancel their second mortgages in bankruptcy when their properties aren’t even worth the value of the first mortgage.
The Supreme Court said it would review two appeals filed by Bank of America against bankrupt homeowners who are trying to remove the bank’s liens on their property.
The two Florida homeowners say that filing for Chapter 7 bankruptcy protection with a first mortgage that is worth more than their property’s value allows them to “strip off” the lien from the second mortgage. When both loans are underwater, the second lien is essentially valueless, the homeowners’ lawyers argue.
Lenders, however, have fought to keep the second mortgage liens, arguing that the debt could someday be fully paid, especially as property values rise.
“There is no such thing as a ‘truly valueless’ lien on property capable of appreciating,” Bank of America lawyers said in court papers.
The 11th U.S. Circuit Court of Appeals upheld bankruptcy court decisions that stripped Bank of America of its liens. The bank appealed.
In court papers, lawyers for Bank of America said that the question “may be the single most important unresolved issue in consumer bankruptcy.”
About 2.1 million borrowers had partly or wholly underwater junior mortgages at the end of the second quarter of 2014, said lawyers for Bank of America, citing a CoreLogic report.
Lobbying groups for the corporate loan market and banking industry, including Loan Syndications and Trading Association and American Bankers Association, plan to fight alongside the bank with a brief.
The Supreme Court can now clarify the rules for bankruptcy judges who have disagreed on this issue. In 1992, Supreme Court justices determined that a bankrupt homeowner doesn’t have the power to cancel the lien on an underwater first mortgage, but it is less clear what power a bank with an underwater second mortgage has in bankruptcy. Second mortgages were far less common at the time of the U.S. Bankruptcy Code’s last major overhaul in 1978.
Lawyers for one of the homeowners said in court papers that if the Supreme Court makes it easier to cancel the lien on a second mortgage, it could “help unclog the housing market.”
A ruling in favor of homeowners could make it easier for people who file Chapter 7 bankruptcy to keep their homes, said Cynthia Riddell, a Florida bankruptcy attorney.
Last year, more than 700,000 individuals and couples filed for Chapter 7 bankruptcy, the most popular type of consumer bankruptcy, which enables a court-appointed trustee to sell a person’s property to repay debts and then cancel the rest.
Before the housing crash, lenders were willing to extend a second mortgage, sometimes in the form of a home equity line of credit that gave the homeowner cash. It is a riskier loan because the first mortgage is scheduled to be repaid first if the homeowner files for bankruptcy.