U.S. Supreme Court Rules that Second Mortgages Cannot be Stripped in a Personal Bankruptcy

Demystifying Valuation, Economic Damages + Forensic Accounting

In early June 2015, the U.S. Supreme Court ruled that homeowners who have an “underwater” second mortgage on their home – one with a mortgage balance that exceeds its current value –cannot be stripped off or dismissed in a Chapter 7 bankruptcy proceeding.

This recent court decision is going to dramatically impact homeowners who are struggling in this economy and are considering filing for Chapter 7 bankruptcy protection. In order for the homeowners to retain ownership of their home, they will have to assume the debt on not only the first mortgage but the second mortgage as well, even if the current value of the home is less than the amount owed on just the first mortgage. This ruling is going to make it more difficult for homeowners to emerge from bankruptcy protection and retain ownership of their home since this additional debt will impact their personal budgets.

The Supreme Court unanimously voted against two homeowners in Florida, where the two homeowners had both won before the local appeals court where it had ruled that homeowners in Chapter 7 bankruptcy can have a second mortgage dismissed (also known in bankruptcy terms as “stripped off”) even when the debt that is owed on just the first mortgage is more than the current value of the house. But Bank of America, which was the second mortgage holder in both cases, challenged the appellate court’s decision and won. The Supreme Court not only reaffirmed, but extended its controversial decision in prior cases which the Court had held that a Chapter 7 debtor cannot “strip down” a partially underwater mortgage.

One of the peculiar consequences of this ruling is that if the homeowner cannot afford both mortgages, the bankrupt homeowner will simply have to allow the first lienholder to foreclose on the home which will cause the second mortgage to be wiped out completely anyway.

By Ted Burr, CTP, CIRA