A U.S. Supreme Court ruling this week ensuring banks can pursue home-equity borrowers for payments in bankruptcy may give a boost to lending.
The nation’s highest court handed a victory to Bank of America Corp. by overturning a decision by a federal appeals court that extinguished a home-equity mortgage on an underwater property in Florida. The practice, known as lien stripping, had become common in some states after the Court of Appeals in Atlanta approved it more than two years ago, according to bank lawyers.
Banks are originating home-equity loans at the fastest pace in seven years as Americans tap into rising home prices to pay for home renovations, college and cars, according to Equifax Inc. The unanimous court decision may spur even more home-equity lending by reassuring lenders they can try to recoup losses in a Chapter 7 bankruptcy, said Thomas Norton, president of Norton Group, a bank consulting firm in Princeton, New Jersey.
“The risk for all lenders is less today than it was the day before the court’s decision, which means they’re going to be more willing to grant someone a home-equity loan,” Norton said. “This ruling means if someone hits a bump in the road, lenders are more likely to get some of their money back.”
The court’s ruling on June 1 comes as rising home prices make it more likely that lenders can collect payments from bankrupt borrowers. The median price of a U.S. existing home has surged 42 percent in the last three years, according to the National Association of Realtors. Almost 1.2 million properties regained equity in 2014, according to CoreLogic Inc.
“Given that we’re in the middle of a market upswing, it’s very plausible and very likely that many of these mortgages will regain equity,” Danielle Spinelli, a Bank of America attorney, said in oral arguments in front of the Supreme Court on March 24.
Lawrence Grayson, a Bank of America spokesman, declined to comment on this week’s decision.
Lenders originated $9.5 billion of home equity lines of credit in January, the most popular type of second mortgage, a gain of 27 percent from a year earlier, Equifax said in its May 19 report. Banks have $483.9 billion of Helocs on their books, according to the Federal Deposit Insurance Corp. Bank of America is the largest holder, with $73.3 billion.
“If the court had allowed lien-stripping to continue, banks would have put the kibosh on home-equity lending,” said Richard Green, sales manager in the mortgage division of Presidential Bank in Bethesda, Maryland. “They immediately would have started looking at ways to take some risk off the table. They would have wanted more equity in the game before they made the loans.”
The legal victory for lenders may be short lived, said Ray Warner, a professor of law at St. John’s University in New York. The court’s ruling said a “straightforward” reading of the Bankruptcy Code doesn’t support Dewsnup v. Timm, the 1992 Supreme Court decision that set the precedence for protecting second mortgages.
This week the court pointed out in its seven-page decision that it had not been asked to overrule Dewsnup.
“It’s very unusual to see the kind of language they used,” said Warner. “It sounds like they might have wanted to overrule all or part of Dewsnup, but hesitated to do so” without fully vetting the issue, he said.
While homeowners can strip off a valueless second mortgage in all states by filing in Chapter 13, the legal fees are higher compared with Chapter 7, and the debtor may have to pay some of the unsecured debt over five years, said Robert Lawless, a law professor at the University of Illinois.
Almost 1 million people filed for bankruptcy in 2014, according to the American Bankruptcy Institute. About 66 percent used Chapter 7, in which the courts sell all non-exempt property to pay off creditors.
“Bankers are sure to be happy” with the court’s ruling, Lawless said. “Homeowners in bankruptcy won’t be happy. If they can’t wipe out their unsecured debt, it doesn’t give them the fresh start that’s at the heart of the bankruptcy code.”