The nation's largest banks might want to take a hint from a recent upswing in Chapter 13 bankruptcies by people who have second mortgages. The four largest issuers of both first and second mortgages, Bank of America, Wells Fargo, JPMorgan and Citibank hold nearly $435 billion of the $1 trillion second mortgage market, and they could face staggering losses if the trend continues.

Mortgage borrowers generally seek loan modifications before even considering filing for bankruptcy. When they face too many roadblocks to debt negotiation with their banks despite government programs like the Home Affordable Modification Program (HAMP), however, they often find that Chapter 13 is a way to keep their homes while ditching unaffordable second mortgage liens.

Bankruptcy Courts Can Reclassify Second Mortgages as Unsecured

In the case of an underwater mortgage, where a home has an appraised value of less than the amount owed on the first mortgage, Chapter 13 can offer an unexpected life raft for some drowning debtors. The homeowner can petition the bankruptcy court to reclassify the second mortgage from secured debt to unsecured, which does not have to be paid in full.