Tuesday, April 13, 2010

Strategic Defaulters Be Aware : Lenders Will Go After Borrowers Personally For Unpaid 2nd Mortgages aka Junior Liens

The Wall Street Journal's recent report Second Mortgages Vex Borrowers by James R. Hagerty outlines lenders decision to go after borrowers for unpaid second mortgages.

There are borrowers who have second mortgages on their property. The second mortgage can be the "20" from an "80/20" loan. Essentially an "80/20" loan allowed a primary lender to lend 80% of the purchase price. A secondary lender would lend 20% of the loan price. This added up to 100% of the purchase price thereby allowing a property buyer to put very little money down. The second mortgage aka junior lien can also be a home equity line of credit ("HELOC"). Many borrowers took out a HELOC as a way to have extra cash. A borrower could draw against the HELOC when they needed cash. They turned their property into cash machine. Whether it was a "20" of the "80/20" or a HELOC, these second mortgages held a higher interest rate then the first mortgage. Furthermore, most of these second mortgages are essentially unsecured. Now that property prices values have declined significantly and property owners are "upside down", there is no way a lender can collect on the second mortgage from a foreclosure sale or short sale. There is not enough money.

The WSJ points out that according to Federal Reserve Date there are "$1 trillion of junior-lien mortgages outstanding in the U.S. at the end of 2009".

So how can lenders collect on 1 trillion dollars worth of second (junior-lien) mortgages when lenders cannot collect from the sale of a property? The lender can sue.

Understanding this is very important to borrowers with second mortgages. Basically, the lender will sue a borrower personally for the amount that is owed. Even if a lender cannot collect on a second mortgage through foreclosure or sale of the property, the lender has a right to sue the borrower personally. A second mortgage is a debt obligation that is secured by a piece of property and secured by a borrowers personal promise to pay. Please read What Everyone Should Know About Debt Forgiveness, Obligations and Deficiency to better understand debt obligations.

In the past, lenders would write this off. Lenders did not want to incur the costs of chasing a debtor. Also, lenders did not have 1 trillion dollars worth of second (junior lien) mortgages outstanding. This is a lot of money sitting on the table.

This is also big businesses. Debt collection companies are purchasing these second mortgages at cents on the dollars. For example a debt collection company may purchase a second mortgage originally valued at $150,000 for $50,000. The debt collection company can locate the original borrower and offer the borrower a 50% reduction on the $150,000. At 50% of $150,000, the borrower agrees to pay $75,000, The debt collection company offers the borrower a two, three, or four year payment plan. The debt collection company has made a tidy profit on a $50,000 debt purchase.

A lender holding a second mortgage does not have to wait until a foreclosure or sale of the property. A lender can sue the borrower anytime after a default in the payment.

Keep in mind, when a borrower decided to strategically default, in most instances the borrower has sufficient income and assets to keep paying. It is not difficult for a lender to investigate a borrower's financial profile. In other words, lenders will aggressively go after strategic defaulters since it is likely a lender will collect something instead of nothing.

There are state and federal laws that protect borrowers in certain circumstances. It is necessary to get professional advice regarding all available options.

To quote from the WSJ article, "A spokeswoman for Bank of America said that if efforts to avoid a foreclosure failed, "then we do reserve the right to recover the unpaid balance on the second lien if permissible by state law. However, our practice has been to only to pursue recovery in situations where we believe the customer has sufficient nonretirement assets to satisfy their debt obligation."

Any person considering a strategic default : Be Aware.

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