Court: Second mortgages can be “stripped” during Chapter 7 bankruptcy
Although home prices have been steadily gaining ground throughout the country in recent months, many Florida homeowners continue to live in homes that are still valued significantly lower than during the market peak in 2008. Sadly, this means that a substantial portion of these homeowners owe more on their mortgages than their homes are worth, thus making them severely “underwater.”
Fortunately, some additional relief may be available for many of these Florida homeowners if they happen to have a second mortgage and are considering bankruptcy as a way to deal with their overwhelming debt. Specifically, a court decision out of the Eleventh Circuit Court of Appeals – the Circuit Court for Florida bankruptcy courts – has determined that underwater homeowners can eliminate and “strip-off” second mortgages through the Chapter 7 bankruptcy process.
Eliminating second mortgages during Florida bankruptcies
Essentially, the ability to eliminate second mortgages through bankruptcy is rooted in the fact that underwater homes are worth less than their outstanding mortgages. For instance, imagine a Florida homeowner bought a house at the height of the market for $750,000, but it is now only valued at $400,000. If this particular home has an outstanding first mortgage of $500,000, and a second mortgage of $200,000, the lender holding the second mortgage will no longer be regarded as a secured creditor since the home is no longer valued high enough to create a security interest. Because the second mortgage is now unsecured, it can be stripped off during bankruptcy, thus eliminating the homeowner’s liability to pay this second mortgage.
In the past, many jurisdictions only permitted individuals to strip second mortgages during Chapter 13 bankruptcies, which is the form of consumer bankruptcy in which the debtor is subject to a repayment plan of three to five years.
However, an important Eleventh Circuit case – In re McNeal – dictates that individuals also can strip second mortgages through Chapter 7 bankruptcies. This distinction is important given the fact that Chapter 7 debtors are not required to stick to a multi-year repayment plan like those enforced during a Chapter 13 bankruptcy. And, while this case was previously only considered persuasive law, it was recently designated as “published,” meaning it is now carries the weight of law in the Eleventh Circuit, which includes bankruptcy courts in Florida.
Interestingly, several other jurisdictions have rejected the idea of stripping second mortgages during Chapter 7 bankruptcies – meaning underwater Florida homeowners have a significant advantage that many homeowners in other states do not enjoy. However, the process of mortgage stripping can be quite complex, which is why it is generally best to consult with an experienced bankruptcy attorney if you are upside-down on your home and believe bankruptcy may be able to help.