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Supreme Court case will affect debtors with underwater mortgages

It’s a scenario thousands of Americans can identify with. After the housing bubble burst in the late 2000s, home values plummeted. Homeowners found themselves owing more on their mortgages than their homes were worth. Many also had second or even third mortgages, all underwater.

Chapter 7 bankruptcy was a solution for a significant percentage of these homeowners. It allowed them to eliminate (or “strip off,” in bankruptcy parlance) the subordinate mortgages, which in turn freed them up to focus on modifying or making progress on their primary mortgage.

Banks have since challenged homeowners’ ability to strip liens associated with second mortgages. A number of cases have made their way through the federal appellate courts, resulting in conflicting decisions. The U.S. Supreme Court will resolve the conflict in an upcoming decision.

This morning, the court heard oral arguments on a duo of key bankruptcy cases, Bank of America v. Caulkett and Bank of America v. Toledo-Cardona. Both raise an important question: Does the Bankruptcy Code allow judges to strip away second-mortgage liens on homes that are underwater?

Two decades ago, the Supreme Court heard anther bankruptcy case addressing a similar issue. In that case, the court rules in favor of the banks. Today the court’s substantially different composition – as well as the different facts at issue – may result in a different outcome.

One thing is clear: The stakes are high for both sides. Banks stand to lose staggering sums of money, especially with home values beginning to rise again. Debtors stand to lose their homes and, in many cases, their ability to regain financial security. The decision will affect the thousands of Americans still struggling with financial hardship after the real estate collapse.

Source: SCOTUSblog, “Argument preview: Underwater mortgages and the Bankruptcy Code,” Amy Howe, March 24, 2015.

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