CAN COMPLETELY UNSECURED OR “UNDERWATER” MORTGAGES BE ELIMINATED THROUGH FILING FOR BANKRUPTCY?
The premise can be explained somewhat simply: a second mortgage is completely underwater. The mortgage is no longer attached to ANY equity in your house because the first mortgage eats up all the value of the house. This kind of thing is pretty common after the 2008 financial crisis. Home values plummeted. The bottom “dropped out” of many real estate markets.
If a second or third mortgage has no ACTUAL secured interest in your real estate because the first mortgage by itself exceeds your home’s value, the bankruptcy code appears to allow you to avoid these second or third mortgages that are “wholly unsecured.” Section 506 of the bankruptcy code along with relevant sections should in theory allow the avoidance of such a “wholly unsecured” mortgage in either a Chapter 7 or Chapter 13 case.
However, courts are split on the decision of when (if ever) “underwater” mortgages can be avoided in bankruptcy. The bankruptcy courts usually fully deny such an avoidance under a Chapter 7 case. Although there are some conflicting opinions, several bankruptcy courts, including the Indiana Southern District (Indianapolis’s Court), allow such wholly unsecured mortgages to be avoided only in Chapter 13 filings.
Challenges to the inability to strip wholly unsecured mortgages during Chapter 7 cases have lead to the recent in Supreme Court decision of Bank of America v. Caulkett. In this case, the Supreme Court made very clear that they would not allow avoidance of “unsecured mortgages” in Chapter 7 cases simply due to the lack of previous precedent being an “unfair taking” of potentially valuable rights of these mortgage holders.
Bank of America argued the value of retaining their secured status: the right to receive payments and the benefits of retaining their liens to realize future gains in value. The Supreme Court decided to allow wholly unsecured mortgage avoidance in Chapter 13 but denied it for all Chapter 7 cases.
Therefore, the rules remain the same for greater Indianapolis-Area bankruptcy filers. You can “avoid” a wholly unsecured mortgage in Chapter 13 potentially, but the right to avoid a wholly unsecured mortgage will NOT be allowed still in Chapter 7 cases.
If you are interested in any form of debt relief, especially in stripping mortgages off your home, give our office a call.
~Indianapolis Bankruptcy Attorney John F. Bymaster