Judge Leslie Tchaikovsky, a local Federal bankruptcy judge, zaps lenders who were, in effect, basing their credit decisions on collateral value only (and apparently shopping for inflated appraisals, to boot). From Calculated Risk, “BK Judge Rules Stated Income HELOC Debt Dischargeable:”

This is a big deal, and will no doubt strike real fear in the hearts of stated-income lenders everywhere. Our own Uncle Festus sent me this decision, in which Judge Leslie Tchaikovsky ruled that a National City HELOC that had been “foreclosed out” would be discharged in the debtors’ Chapter 7 bankruptcy. Nat City had argued that the debt should be non-dischargeable because the debtors made material false representations (namely, lying about their income) on which Nat City relied when it made the loan. The court agreed that the debtors had in fact lied to the bank, but it held that the bank did not “reasonably rely” on the misrepresentations.

As Tanta points out, stated-income lenders expected the borrowers to lie, and assumed that the borrowers’ misrepresentations would allow them to escape liability for imprudent lending when the loan owners tried to put back the defaulted paper.