In 2015, the US Supreme Court ruled that Second Mortgages and Home Equity Lines of Credit may not be dischargeable in bankruptcy even if the entire amount of the loan is underwater.
By underwater we mean that the value (FMV) of the home is less than the amount of the first mortgage.
Until this recent court ruling, the second mortgage could be “stripped out” and converted from a secured debt to an unsecured debt under Chapter 13 rules. Stripping out a debt means that a debtor could “wipe out” that loan in bankruptcy and enable the debtor to avoid having to pay it back.
This is a big victory for banks and a major defeat to the homeowner in bankruptcy. As a result of this ruling, any homeowner seeking to hold on to his/her home, he/she will have to pay back both the first and second mortgages, without regard to how much the total debt is in excess of the property value.
This ruling is not only devastating to individual homeowners, it may cause disastrous results in regions such as central Florida where 23 % of the state’s underwater homes have second mortgages.
We will likely see more foreclosures and more Chapter 7 filings, causing many homeowners to lose their homes. The Supreme Court decision leaves the homeowner no other option but to walk away from their property. This ruling may help the big banks, but it will really hurt the individual homeowner who is certainly not “too big to fail.”