Bankruptcy Law Blog

Friday, July 3, 2015

Supreme Court Issues Ruling on ‘Underwater Mortgages’ & Bankruptcy

I currently owe more on my home than it is worth, and I currently have two mortgages on the property. If I pursue Chapter 7 bankruptcy, will the debts be discharged? 

The phrase “Chapter 7 bankruptcy” derives its name from the seventh chapter of the U.S. Bankruptcy Code wherein debtors are afforded an opportunity to liquidate a number of debts and forever discharge the obligations. While not all debts are dischargeable (e.g., child support arrears), a number of both secured and unsecured debts may be voided following the Chapter 7 procedure. 

In a recent case before the U.S. Supreme Court, the nine Justices were tasked with determining whether, in the event a debtor is ‘upside down’ on his residential home loan, he could discharge junior liens when the value of the property does not even cover the outstanding balance of the primary mortgage. In other words, if a property is encumbered by two or more outstanding mortgages, can its diminished value work to eliminate those mortgages executed at some point after the first and primary mortgage. 

And, in a rare, resounding, unanimous opinion: No. 

With all nine justices in agreement, the Court held that Chapter 7 liquidation proceedings are not designed to allow for the dismissal of junior liens, regardless of the value of the home and the surrounding circumstances. Also unusual, the opinion barely reached seven pages, and took a straightforward, objective approach to the problem by asking: What does precedent say?  

In 1992, the Court considered a similar case involving a partially-underwater residential home mortgage meandering its way through the bankruptcy process. In that case, the plaintiffs urged the Bankruptcy Court, and eventually the Supreme Court, to reduce the value of the outstanding lien to that of the fair market value of the home. That way, when the collateral was sold, the bank holding the original mortgage would be paid off in full and any remaining liens would be discharged. However, the Court didn’t buy that argument in 1992, and it didn’t opt to buy it today. 

Instead, the Court held that junior liens must remain in place, even if the value of the home is nowhere near enough to conceivably pay the debt. 

If you are considering personal bankruptcy, contact Mobile, Alabama’s premier bankruptcy law firm, Padgett & Robertson today at (251)342-0264. 

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