Bankruptcy Discharge of 2nd Mortgage Not a Loophole

Posted May 9, 2011 in Creditor/Debtor by Arthur Buono

The news that some homeowners have been able to shed second mortgages in bankruptcy proceedings isn’t news to seasoned bankruptcy attorneys. It’s not something peculiar to home equity loans either. It could provide a bit of a lift to the double-dipping housing market.

  • Bankruptcy law permits discharge of unsecured debts
  • Second mortgages may become unsecured by falling home value
  • Second mortgage holders have been holding up short sales
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Risk Comes Home to Roost for Perilous 2nd Mortgages

Despite some reports, this is not a loophole. The law and the mechanics of it are open and straightforward. And it applies to all subordinate security interests equally, no matter what the collateral is.

Secured debts get preferential treatment in bankruptcy. Unsecured debts usually can be discharged if the debtor has insufficient income or assets to pay them. Second mortgages, though secured at funding, can become wholly unsecured if a home falls in value below what is owed on the first mortgage. Of course that’s happened in spades the last few years.

How might this help a housing recovery? Banks and other investors that hold seconds have held up short sales, refusing to release liens on deals where they wouldn’t get paid in full. Short sales are far better for the market than a frequent alternative – foreclosure by the first mortgage holder, a process which, ironically, extinguishes the second lien and usually results in the second getting nothing too.

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