1. Chapter 7 filers take the biggest hit
Chapter 7 bankruptcy is designed to give debtors a fresh start by wiping out unsecured debts, regardless of how much is owed. Up until now, that meant that if you had a second mortgage on your home that exceeded the property’s value, it could technically be zeroed out in a Chapter 7 case. The court’s ruling is eliminating that protection, making it harder for financially strapped homeowners to get relief.
Now you’ll no longer be able to do away with a second mortgage loan in Chapter 7 even if the home’s value is less than the first mortgage. The end result is that you’d still be on the hook for any secondary loans you owe. If you’re already behind on your payments for a home equity line or similar second mortgage loan, you’d have to get caught up to avoid the possibility of foreclosure.
Did you know? A Chapter 7 bankruptcy filing can remain on your credit for up to 10 years.
2. No penalty for Chapter 13 debtors
While the court’s ruling is a major defeat for homeowners who are contemplating Chapter 7, there’s still a potential escape route in the form of a Chapter 13 case. With this type of bankruptcy filing, you’re allowed to get caught up on your outstanding debt payments over a period of 3 to 5 years without having to turn over any of your assets for liquidation. In a Chapter 7 filing, you’d have to surrender any assets that aren’t exempt under federal or state bankruptcy laws.
Secured debts are given priority in a Chapter 13 case for repayment purposes. If you’ve got a second mortgage loan that exceeds the home’s value, the court views that as an unsecured debt similar to a credit card or medical bills. As long as you complete the repayment plan that you and the court have agreed on, you won’t owe the additional mortgage debt once your case is discharged.
Tip: Filing a Chapter 13 bankruptcy case can temporarily stall foreclosure proceedings and other collection actions.
3. What the ruling means for banks
The Supreme Court’s decision is clearly a victory for banks, especially those who extended tens of billions of dollars in second mortgage loans during the housing boom. The ruling gives financial institutions an upper hand when it comes to recovering delinquent second mortgage debt since there’s no the longer the threat of their claims being challenged in a bankruptcy filing.
The court based its decision in part on changing real estate values but that doesn’t do much to soften the blow for homeowners who are behind the eight ball with their mortgage lenders. In fact, it’s easy to see the ruling as yet another reward for banks’ bad lending behavior, which largely contributed to the housing collapse and the current financial woes many homeowners are facing.
Chapter 7 bankruptcy is designed for people who are overwhelmed by debt and don’t have enough money coming in to make a dent in it. Taking away some of its protections allows banks to keep more money in their pockets while homeowners pay the price.
Homeowners who modified their first mortgage loan through the HAMP program may be eligible for a modification of their second mortgage but obviously, that’s not going to apply to everyone. The reality is that without Chapter 7 as an out, underwater homeowners now have very limited options for dealing with second mortgage debt.
Infographic: The shifting mortgage industry
The mortgage industry has changed dramatically over the last several years so to put things in perspective, we’ve created an infographic of the most important shifts that have taken place.