Prior to this 1993 case, various courts across the country had issued conflicting opinions as to whether a Chapter 13 debtor could repay a secured mortgage on his/her residence by classifying the loan as secured only to the extent of the value of the property and proposing to repay the balance as an unsecured creditor.

Here, in the case of Leonard Nobelman v. American Savings Bank (U.S. Supreme Court, No. 92-641 (1993), the debtors owed more than $71,000 on a loan from American Savings Bank secured by the debtors’ residence. The loan was issued nearly 10 years ago; the mortgaged property has depreciated in value since issuance of the loan. The uncontroverted value of the debtors’ residence was only $23,500 when debtors’ filed for bankruptcy.

Debtors’ Chapter 13 plan proposed that the mortgage on their residence be reduced from the more than $71,000 owed to the bank to the $23,500 valuation; debtors’ plan further provided to classify the balance of $47,500 as an unsecured claim. The plan provided for no payments to unsecured creditors.

The Supreme Court held that Section 1322(b)(2) of the Bankruptcy Code prohibits a Chapter 13 debtor from reducing an under-secured homestead mortgage to the fair market value of the mortgaged residence.

The court reasoned that to permit the debtor to reduce the balance owing on this secured loan would ultimately modify the creditor’s rights which include, among others, the right of repayment of the principal and interest over a fixed term.

EDITOR’S NOTE:  2005 Bankruptcy Code provisions provide for variations of the ruling above.

Author: Charles R. Harroun, Attorney at Law