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Second mortgage may not be canceled in Chapter 7 bankruptcy

New Jersey homeowners may need to be aware that the U.S. Supreme Court recently ruled that a second mortgage on the filer's residence may not be considered an unsecured debt and be discharged in a Chapter 7 bankruptcy. Even if the value of the home is less than the first mortgage, the second lien will not automatically be stripped. The case originated after Bank of America insisted that the second lien of a Chapter 7 filer remain intact, even if the bank will not receive any proceeds from the sale of the home.

The filer claimed that since the home was severely underwater, the second mortgage should be treated as an unsecured debt. Unsecured debts are routinely discharged in a Chapter 7 bankruptcy while priority is given to creditors with secured debts, which means that they are backed by collateral such as a home or vehicle. The court unanimously agreed with Bank of America that the lien should continue to be considered a secured debt, which means that the homeowner would remain liable for the balance after the bankruptcy.

Considering the fact that many New Jersey homes are underwater, this ruling could be significant to homeowners who want to file for bankruptcy protection. It is important for them to know that the court has reaffirmed an earlier decision that second mortgages and home equity loans will more than likely not be discharged. Therefore, residents should use caution before taking out these types of loans.

Just because these loans cannot be discharged in a Chapter 7 bankruptcy does not mean that a homeowner would not benefit from filing. Other debts can be discharged that could ease the financial stresses that come with overwhelming debt. Filing could also provide a much needed reprieve from collection efforts, which could provide the time and space needed to create a plan for a new financial future.

Source: fool.com, "Why the Supreme Court Sided With Bank of America Over Homeowners", Jay Jenkins, June 7, 2015

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