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Court rules in favor of banks on second mortgages.

Chapter 7 bankruptcy is widely thought to be a proceeding through which all of a person’s debts can be discharged. There are certain exceptions to this rule, however, which further emphasize the importance of having professional advice before deciding whether to file and, if so, which type of bankruptcy will be the best option. A recent United States Supreme Court case is a good example of the nuances of bankruptcy law.

For those familiar with bankruptcy law, it is probably not surprising to know that a mortgage that secures a home is generally not dischargeable in Chapter 7 bankruptcy. The word "secures" is the key here: Chapter 7 bankruptcy may cancel all unsecured debts, but secured debts, such as mortgages, generally survive the proceeding.

In the case, the debtor tried to discharge a second mortgage on his home. The theory was that the mortgage was essentially no longer secured because, due to the collapse of the real estate market which affected homeowners throughout the country, including in Ohio, the value of the home was not sufficient to satisfy even the first mortgage, let along the second.

But the bank holding the mortgage argued that the value of the home was not its concern but rather that the debtor repay the debt. If the debt wasn’t cancelled, the debtor would still be required to eventually pay off the loan. The Court agreed with the bank, citing a case from 1992 that held that the value of the property securing a second mortgage, or lack thereof, is basically irrelevant to whether the debt should survive the bankruptcy.

While the ruling didn’t change the existing law, it is an example of the surprises that may lurk in a bankruptcy proceeding. Some of these surprises can be in the favor of the debtor with the proper legal advice. Going it alone without an attorney’s advice could mean the difference in which party encounters the unpleasant surprises.

Source: The Motley Fool, “Why the Supreme Court Sided With Bank of America Over Homeowners,” Jay Jenkins, June 7, 2015

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