When foreclosure of a house is a threat, many homeowners seek debt relief through bankruptcy. A fairly common theme in this type of situation is the presence of a second mortgage. Another common aspect in this scenario is that homeowners are unaware of the second mortgage on their home. How does this happen?
We recently discussed foreclosure and second mortgages with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. Below is a transcript of that conversation.
Jess Smith: We’ve recently had several clients come to us with a foreclosure problem. We’ve been ready to file their bankruptcy, thinking they only have one mortgage on the property that is under water, and it turns out they actually have a second mortgage, because they’ve been in trouble before and entered loss mitigation. They basically granted a second mortgage that is now held by the U.S. Department of Housing and Urban Development (HUD) with no minimum payment and no interest. But, the loan is due either in 30 years or upon sale of the house or upon refinancing of the existing note. The majority of people who come to us to get help with their first mortgage have no recollection of this second mortgage.
Q: These are secured loans?
Chris Holmes: Yes, these are secured loans. They were behind right before closure so they took the arrearage and made it into a note and second mortgage with no payment due.
JS: So they don’t get a monthly bill. They didn’t do a loan modification on the original mortgage, they default on it again, and so they’re sitting here in a foreclosure and they bring in the foreclosure documents and we have to tell them they have a second mortgage. If we can prove they are still under water with the first mortgage, we can get rid of that HUD mortgage in Chapter 13.
Q: Can you expand on the different types of second mortgages you can acquire other than from a bank?
JS: What was probably more common 10 to 15 years ago was when people would get what was called an 80-20 mortgage. If they didn’t put enough money down to qualify for a certain loan, so they would get a loan for 80% of the total amount financed and then get a subsequent loan for 20% of the amount financed, in order to get the lower rate on the first mortgage. So they would have two mortgages basically granted at the same time when they purchased the house.
CH: Instead of borrowing 100% from the first lender, the lender would let them borrow 80% as a first mortgage. They would then borrow the other 20% and turn that into a second mortgage. The loans were then recorded within minutes or seconds of each other. We saw that quite a bit 10 to 15 years ago. Now, we hardly see that at all.
Q: Are there any other agencies besides HUD that provided those types of second mortgages?
JS: It’s usually just the Department of Housing and Urban Development. I think the way these mortgages are created is when the homeowner gets in trouble the first time, HUD will cut a check to the original lender to bring the debt as current; they’ll restructure the interest rate and the payment terms, but HUD just doesn’t give the default amount to the lender. They hold that as a second mortgage. Most people either just forget about it or they have so many pieces of paper shoved in their face – when they know this is how much I have to pay on the first mortgage – they have no recollection that there is a second mortgage out there. So they come see us very late in the foreclosure process.
Q: You mentioned that they may not even be making payments on the HUD loan. What are the various types of terms that could be applied to that second loan?
JS: Typically, the terms are no interest, a maximum maturity of 30 years, or the loan becomes due upon sale of the real estate or the refinancing of the first mortgage.
Q: If it is a no interest loan, does the borrower need to be making monthly payments on that amount?
JS: They are not required to, but the odd thing is that they can get rid of it in Chapter 13 bankruptcy. if when they file the bankruptcy they owe more on the first mortgage than what the house is worth.
Q: What exactly does “get rid of” mean in regards to the second mortgage?
JS: Basically, a lien strip.
CH: It’s called a motion to avoid a wholly unsecured mortgage. So as long as we can persuade the judge that the value of the home is exceeded by the payoff on the first mortgage, there’s no equity to which the second mortgage can effectively attach, because they are wholly unsecured, the law says you can get rid of, or as we say, strip, or avoid that – turn them from a secured creditor into an unsecured creditor, so down the road when the house is to be sold, there is no need to pay that second mortgage. It’s wiped out just like a credit card debt is wiped out.
Q: is that for both Chapter 7 and Chapter 13?
JS: That’s only available in Chapter 13.
CH: That’s one of the primary reasons we recommend Chapter 13 for some people in that circumstance. In a Chapter 7, you’re stuck with that second mortgage. Only in Chapter 13 do we have the clout to get rid of it.
JS: I met with a gentleman earlier today whose house on the east side of Indianapolis is up for Sherriff’s sale in a couple of weeks. He can’t find his foreclosure complaint. All he brought in was the notice of the sale. I went to the state court chronological case summary, and the Department of Housing and Urban Development is named as a defendant in the foreclosure. So, before we file the case, I have to see if there is a second mortgage, and if there is, I need to pay real close attention to what his house is worth to see if there is the possibility of eliminating this debt he didn’t even know he had.
Q: In a Chapter 7, they’re going to lose the house?
CH: It’s either make arrangements to pay all mortgages to keep the home or surrender the home to get rid of the debt.
Q: In a Chapter 13, is that second mortgage, which you’re stripping from being secured, rolled over into the pool of creditors so that you’ll still eventually pay pennies on the dollar for that amount?
JS: It’s converted into unsecured debt – lumped together with credit cards and medical bills, etc. – that you might eventually pay anywhere from 1-cent to 100-cents on the dollar. It just depends on what your income ability is to pay back back the debt. But it is converted to an unsecured debt.
Q: Is there a lesson a reader might learn from this case? Why is he filing for bankruptcy?
JS: The gentleman is about 50 years old and currently employed as a machine operator. He earns about $45,00 a year. His wife, who is not filing for bankruptcy, is employed by the government. She earns about $50,000 annually. The primary reason for his financial problem is that he and his wife don’t communicate about income and expenses. The house and the mortgage are both in his name. Her money is her money and his money has to pay for the house. They’ve only had the house for three years, so maybe they just bought too much house. I suspect it is a pattern of lack of communication that has put them in this spot, because he doesn’t seem to know much about her bills and expenses, but she makes over half of the household income.
Q: Did this gentleman come in to see you at you at your East Indy office?
JS: Actually, he came into the North Indy office, because it’s open on Saturday.
If your mortgage lender is threatening foreclosure on your house, contact us to discuss possible options that will allow you to stay in your home while you work to get out of debt.
Additional Resource from HUD: Avoiding Foreclosure