Settling Debt On Secondary Mortgage

Mortgage debt settlement is often easier with a second mortgage (or HELOC) than a first mortgage. That’s because the second mortgage holder usually has less leverage and less protection than the first mortgage holder. That gives the holder of the secondary mortgage more of an incentive to settle.

What is a Second Mortgage?

“Second” in the context of mortgage doesn’t necessarily refer to “time” or “order”—i.e. it’s not always the later mortgage. Instead, “second” means that in the event of default or foreclosure, it’s not paid at all until the first (or primary) mortgage is paid in full. HELOC and home equity loans are usually second mortgages, since they won’t be paid off by the proceeds of a foreclosure sale of the property until the first mortgage—almost always the one used to buy the property—is paid first.

As a practical matter, a second mortgage is usually the second one taken out, but it doesn’t have to be. For example, say that someone takes a mortgage to buy a home; takes out a HELOC and draws from it; then refinances the first mortgage. The refinanced mortgage is taken out after the HELOC, but will be a first mortgage compared to it and will be paid first in the event of foreclosure. The priority of a mortgage—or whether it’s a first or second mortgage—is determined by the terms of the mortgage agreements.

Why Second Mortgages Have Less Protection

As noted above, a second mortgage is only paid, in the event of a default, foreclosure, lawsuit by lenders, etc., after the first mortgage is paid in full. That means that unless there is enough equity and/or cash to pay both mortgages in full, the second mortgage will be not be fully paid—in fact, it may not be paid at all in many cases. This is common in a declining real estate market, where owing to an economic downturn, the home is worth less than the loans on it.

For example, consider a home bought for $300,000 with $30,000 down; that means the first mortgage was for $270,000. Say that after two years, when the first mortgage was paid down to $265,000 principal, the homeowners took out a HELOC for $50,000—the lender had thought that the property had appreciated in value sufficiently to cover the line of credit. However, if instead the property value declines to, say, $270,000, in the event of a default, foreclosure, and foreclosure sale, the first mortgage would be paid in full, while the second mortgage would only receive $5,000. (Actually, it’s even worse than that, because there will be certain administrative costs taken out of the foreclosure sale price.)

Settling Second Mortgages

A second mortgage is riskier than a first mortgage, at least in a declining market or if the homeowner is over-leveraged. A smart lender will recognize this—that their security interest in the property doesn’t actually protect their financial interest. That being the case, the lender may be more willing to settle the second mortgage for a fraction or portion of its principal value, giving up the theoretical possibility of a  larger  recovery in the event of a default—but also the very real likelihood of getting little or nothing—in exchange for a guaranteed payment.

How an Attorney Can Help

Mortgages are legal documents. An attorney can help you understand your rights under your loans and also their relative priorities. The attorney can also negotiate  with lenders on your behalf.

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