Second mortgages are posing additional complications in the already troubled U.S. housing market. Not only are a portion of the homeowners holding them in debt for more than their home’s value, but a resolution of the loans usually becomes part of a foreclosure process.
The home equity loans or lines of credit are popular vehicles for financing different kinds of expenses. But borrowers who have second mortgages to use the equity in their homes for various purposes are hard pressed when housing prices decline. They usually can’t refinance or otherwise modify their loan terms or sell a home if a second mortgage can’t be paid off.
Home equity contributing to being underwater
CoreLogic, a Santa Ana, California-based real estate data provider, released a report in June 2011 showing that nearly 40% of borrowers using the proceeds of home equity loans owe more than their home is worth, known as being underwater. The findings were that homeowners who had borrowed against their home’s equity were more likely to be in this position than those without second mortgages.
“While only 18 percent of borrowers with no home equity loans were underwater at the end of the first quarter, 38 percent of borrowers with home equity loans were in a negative equity position,” Mike Ferullo wrote about the CoreLogic findings in Daily Report for Executives June 9, 2011 in “Data Show 11 Million Home Borrowers Have Negative Equity; Second Loans a Factor.” “About 4.5 million borrowers of the 10.9 million borrowers found to be underwater had second mortgages or home equity lines, the report said. The research firm also found that the existence of second loans significantly increased the severity of the negative equity position."
Robbie Whelan, in “Second-Mortgage Misery” in the June 7, 2011 Wall Street Journal, said: “CoreLogic found that borrowers with second mortgages had deeper levels of negative equity- an average of $83,000 compared with $52,000- than borrowers without second mortgages. In many cases, borrowers withdrew cash from their properties using home-equity loans or lines of credit, a type of second mortgage. The CoreLogic report doesn’t include cash-out refinancing, a common practice during the boom, where borrowers opted to extract cash while refinancing their first mortgage.”
Ongoing problems for homeowners and lenders
Other lenders have faced the consequences of this correlation between second mortgages and negative equity on homes. “Credit unions have often faced increased risks of foreclosures from this phenomenon as the lender on the original mortgage which the homeowner then supplemented with another mortgage from another lender,” wrote David Morrison in “Report Documents Second Mortgage, Foreclosure Link,” in the June 8, 2011 Credit Union Times.
When borrowers can’t pay off second mortgages and a foreclosure on a property occurs, the lender holding the mortgage may continue making efforts to receive their payments. As is usually the case in foreclosures, the first mortgage is paid first in addition to taxes or other liens against a property.
Sometimes a second mortgage can be canceled in a foreclosure. However, this action may not excuse borrowers from repaying the balance of the money which they have legally obligated themselves to do.
Investment adviser Tim Iacono has noted the harm to the second mortgage holder in a foreclosure.
If a property is no longer a source of payment, second mortgage lenders have other avenues to pursue. One step they may take is paying off the first mortgage before a foreclosure sale, thereby making payment of the second mortgage a priority when a home is ultimately sold, though this does not ensure they will receive payment.
Attempts to discharge unsecured debt in bankruptcy
Bankruptcy attorneys also have stepped in when borrowers can’t repay their second mortgages. The money still owed can be considered unsecured debt if a property is valued as no greater than a first mortgage.
Some attorneys counsel that this debt may be discharged in a Chapter 13 procedure because the lender cannot collect on the second mortgage with no backing of property for it.
Critics of this strategy argue that defaulted unsecured debt can be secured against real property if a debtor is sued for an unpaid second mortgage and a court imposes a deficiency judgment holding the borrower liable for the amount owed if foreclosure sale proceeds aren’t enough to cover it.
Other options for second mortgage holders
The second mortgage holder can attempt to send the loan to a collections firm or settle for a lesser payment amount, including lowering the principle. Still, a second lender may refuse to modify the second mortgage if no state requirement exists to do so.
Even if a second mortgagee no longer has property as security on the loan, it can proceed under the mortgagor’s promissory note and reduce the loan balance, some legal authorities contend. The deficiency judgment wouldn’t restrict its options here, in their view, because the lender hasn’t foreclosed its mortgage as it is merely suing on the note.
On occasion in foreclosure the first mortgage holder can intervene and purchase the second loan to protect its interest. A more common outcome is negotiating a short sale of a home with a bank at a lower price than the outstanding mortgage, particularly with underwater homes in a real estate market full of them, a step that can sometimes avoid foreclosure.
But it may be more difficult to reach terms on doing this when a borrower has a second mortgage because the primary and secondary lenders must consent to losses on the sale and on a payment amount. In addition, short sales can hurt the real estate market in some areas of the country.
The situation has reached the point where loan modification specialists have come in and states have called on housing agencies that do business with mortgage servicers to assist homeowners in trying to resolve property value declines in relation to second lien and negative equity problems.
Sources:
- Mike Ferullo, “Data Show 11 Million Home Borrowers Have Negative Equity; Second Loans a Factor, Daily Report for Executives, Bureau of National Affairs, June 9, 2011
- Robbie Whelan, “Second-Mortgage Misery,” Wall Street Journal, June 7, 2011
- David Morrison, “Report Documents Second Mortgage, Foreclosure Link,” Credit Union Times, June 8, 2011
- Tim Iacono, “Home Equity and Short Sales,” Seeking Alpha, June 9, 2011
- Pete Carey, “Short sales called drag on Silicon Valley, Peninsula housing market,” San Jose Mercury News, May 24, 2011
- Alex Strobel, “Second Home Loan Modifications and Negative Equity--Homeowners With Second Mortgages Still Face Various Trials, Red, White, and Blue Press, June 9, 2011
John Seidenberg - John Seidenberg has worked on newspapers, newsletters, radio news, and produced specialized news publications as well as freelance ...
