Supreme Court Rules Underwater Homeowners Responsible for Repaying Second Mortgage

Last year alone, more than 700,000 people filed for chapter 7 bankruptcy, which is the most common form of consumer bankruptcy. Under chapter 7 bankruptcy, a court-appointed trustee sells the person’s property in order to repay debts. Any debts that remain unpaid after selling the property are canceled.

One area that remained unclear was whether or not a homeowner could cancel a second mortgage if the value of the home was less than the cost of the mortgage. Referred to as being “underwater,” approximately 2.1 million homeowner who owe more than their homes are worth are also carrying a second mortgage. According to a recent U.S. Supreme Court ruling these homeowners saddled will still have to find a way to repay the debt.

Supreme Court Determines Homeowners Must Repay Second Mortgage

In its recent ruling, all nine Supreme Court justices unanimously determined that homeowners who are underwater cannot get out of paying their second mortgages by filing for bankruptcy. In other words, even if their properties are no longer worth the value of the first mortgage, homeowners cannot cancel a second mortgage simply by filing for chapter 7 bankruptcy.

In making its decision, Justice Clarence Thomas stated that the court considered the fact that real estate values are “constantly shifting” and that even just a one dollar difference can have an effect on bankruptcy proceedings. Critics of the ruling argue that this decision will make it even harder for homeowners who file for bankruptcy to get a fresh start because they will be forced to pay thousands of dollars in order to keep their homes. This is particularly true for older consumers who typically have far more difficulty with recovering for major financial setbacks due to their limited income.

The Case that Changed Consumer Bankruptcy Laws

The case that resulted in a win for the banks was brought to the Supreme Court when two Florida residents attempted to cancel a second mortgage with Bank of America. According to their argument, the second mortgage was worthless because the first mortgage takes priority. Bank of America, which received support from the Loan Syndications and Trading Associations and American Bankers Association, argued that they should be able to keep their liens on the property because the debt could be paid if property values go back up.

While the 11^th U.S. Circuit Court of Appeals sided with the bankruptcy court and took away Bank of America’s liens, the bank appealed and took the issue all the way to the Supreme Court. Historically speaking, the Supreme Court had previously ruled in 1992 that bankrupt homeowners do not have the ability to cancel their first mortgage even if the house was underwater. The ruling did not make it clear if second mortgages could be cleared away, mostly because second mortgages were far less common at the time.

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