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High Court limits 'lien stripping' option for Chapter 7 debtors

Massachusetts residents who are struggling with mortgage debt need to be aware that the United States Supreme Court limited one avenue through which a debtor can use Chapter 7 bankruptcy to get some relief from stifling house payments.

The Court held that Chapter 7 debtors have no right to "strip off" a second mortgage as part of their bankruptcies. Under other provisions of the bankruptcy code, a debtor is allowed effectively to cancel a second mortgage if the house securing the mortgage is "completely underwater," that is, there will be nothing left for the second mortgage holder once the house sells and the first mortgage gets paid off.

Although the Court seemed a little reluctant to do so, it upheld a prior decision that clearly stated that a second mortgage should still be treated as a "secured" debt even though it realistically would not realize any money from the collateral on the loan. Unlike an unsecured loan, secured loans typically do not get modified or partially paid as part of a bankruptcy. Either a debtor will pay the loan off or the debtor will walk away from a secured loan altogether, leaving others to divide up the collateral.

Some have pointed out that this decision prevents a debtor from doing an end-around a second mortgage and thereby being able to take advantage of the bankruptcy and a more favorable housing market so as to realize a profit on a home. However, those who oppose this recent decision might well wonder what has happened to the core idea that bankruptcy is supposed to get a debtor into a position where or she can have a fresh financial start without being drowned in unresolved debt.

Source: Forbes, "Debtors can't void underwater mortgages in bankruptcy, Supreme Court rules," Daniel Fisher, June 1, 2015

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