Supreme Court hands defeat to struggling homeowners

WASHINGTON (MarketWatch) — Underwater homeowners who file for Chapter 7 bankruptcy protection are still on the hook for secondary loans tied to their properties, the Supreme Court said Monday.

In a nine-to-zero decision, the court said in Bank of America, N.A. v. Caulkett that borrowers whose homes are completely underwater — debtors owe more on a mortgage than the home is worth — cannot void or “strip off” a junior lien when they file for Chapter 7 bankruptcy. A junior lien, such as a home-equity loan, is taken after a first mortgage, and uses a home as collateral.

In the case, two borrowers each had two mortgages on their homes, with Bank of America BAC, -1.82%  holding the junior liens. Both borrowers were underwater and filed for Chapter 7 bankruptcy two years ago. The borrowers wanted to “strip off” the junior mortgages, shedding those debts.

The decision “is a clear victory for mortgage lenders” said Isaac Boltansky, an analyst at Compass Point Research & Trading, a Washington-based investment firm.

“It clarifies the path to recoveries for second lien holders in bankruptcy,” Boltansky said. “This decision will undoubtedly make the bankruptcy process more difficult for impacted borrowers.”

The housing market has healed in recent years, and the numbers of troubled properties and struggling borrowers have dropped. Foreclosure filings recently hit the lowest level since mid-2006, shortly before the housing market started to melt down.

Given the current economy — home prices are rising and the labor market is strengthening — the court’s decision “is likely to be muted in the near-term,” Boltansky said.

But that doesn’t mean that there won’t be consequences, he added.

“The true economic impact of the Supreme Court’s decision may not be seen until the next economic downturn,” Boltansky said.

Courtesy Ruth Mantell