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Second Liens, Bankruptcy and Negative Equity Get Sorted in the Supreme Court

Stuart Quinn    |    Housing Policy

On June 1, 2015, the U.S. Supreme Court released their unanimous decision in the consolidated cases of Bank of America, N.A.  (BAC) v. Caulkett  and BAC v. Toledo-Cardona. In the ruling, the Court determined that Chapter 7 bankruptcy laws do not permit the voiding of a second mortgage in instances where a loss in value on the underlying collateral (the home) results in an outstanding principal balance on the first mortgage that exceeds the value of the collateral. In other words, since the first mortgage loan-to-value exceeded 100 percent, the respondent suggested that the second lien was wholly unsecured debt and should be “fully stripped” from the property in the bankruptcy proceedings (e.g: first =$176,413; second =$44,444 on a property worth $141,416). The Supreme Court upheld the 1992 reasoning of Dewsnup v. Timm, which says that chapter 7 bankruptcy proceedings do not allow for a junior mortgage lien to be voided if the senior lien exceeds the value of the property.

In Dewsnup v. Timm, the Supreme Court ruled that “lien-stripping,” a partially secure claim (or “partially underwater”) to the current market value was not allowed so long as the claim is secured by a lien. In the 2012 case, McNeal v. GMAC Mortgage, LLC the Eleventh Circuit held that a debtor may “strip off” or void a junior lien where the senior lien exceeds the house’s present value. The Eleventh Circuit then denied a rehearing and applied the McNeal decision to the consolidated Bank of America cases, leading to the U.S. Supreme Court decision. The inconsistent application raised the question of whether cases of partial value (Dewsnup: “stripping down”) have relevance to the case of a lien determined to have no value (McNeal v. GMAC Mortgage, LLC: “stripping off”).

Both petitions granted certioraris were cases initiated in the Eleventh Circuit Court, where negative equity properties by CBSA continue to saturate the top 25 list. As mentioned in previous Insights Blog posts, over 50 percent of home equity lines of credit (HELOCs) are located in California, Florida and New York [1]. CoreLogic estimates that nearly 2 million borrowers nationwide who are upside down hold both first and second liens on their property with an average underwater amount of $78,000 and an average mortgage balance of $295,000.

[1] A Ripple, Not a Wave; Predicting the Impact from Future HELOC Loan Resets

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