In the wild heyday of mortgage lending, many people were offered two mortgages when buying a house. The first mortgage was a traditional mortgage for 80 percent of the value of the home. But for borrowers who wanted to buy without a down payment, lenders also offered a second mortgage to cover the down payment and help the borrower avoid having to pay private mortgage insurance (PMI). These were called piggyback loans.
When housing prices started to take a dive, the traditional 20 percent of equity borrowers used to have as security in their house wasn’t there, since it had been leveraged by the second mortgage. Without this cushion, when a borrower needs to sell his house or can’t make the monthly payment, the selling price won’t cover the mortgages and so the borrower can’t pay them off.
In most Minnesota foreclosures, the first mortgage company can only collect whatever it can get from the sale of the house. If the selling price doesn’t cover the mortgage and there’s still debt owed, it’s wiped out by the foreclosure. It’s a different story for second mortgages. Under Minnesota law, a second mortgage company can collect a deficiency (the amount owed beyond the balance that’s paid off by the foreclosure.) This means many people after foreclosure are still being chased by second mortgage companies for balances somewhere in the tens to hundreds of thousands.
So what do people do when they are in danger of being sued for a deficiency judgment? Here are some ideas:
1. Do short sales work? Sometimes. A short sale is where the lender agrees to sign off on the sale of a house and take a reduced amount on their loan so that they don’t have to go through the foreclosure process. We’ve heard of some short sales where the second mortgage lender accepts some modest amount of cash and agrees not to pursue the borrower for any remaining debt. But these are becoming more infrequent. In other cases, second mortgage lenders are taking the cash and signing off on the sale, but reserving the right to go after the borrower for the difference. Short sales can be risky, and there are lots of sharks in the real estate industry, so we recommend doing this only if you have an attorney you trust looking over the deal.
2. Can I negotiate with the second mortgage lender after the foreclosure? Sure. Considering the huge amount of money some mortgage lenders are collecting on a deficiency, many times they know they don’t have a prayer of collecting their money. That’s why they might be willing to take a fraction of the amount owed just to get something from you. When mortgage companies are willing to settle, we’ve seen the best deals when borrowers are willing to pay a settlement in one lump sum rather than lots of smaller payments.
3. Can bankruptcy wipe out a second mortgage? Definitely. Many clients come to us facing tens of thousands of dollars in deficiency judgments, and we’re able to discharge these debts in bankruptcy. This is one of the biggest reasons our clients file bankruptcy. A defaulted second mortgage is treated as unsecured, nonpriority debt in bankruptcy, which is pretty much the same as credit card debt. This means we don’t generally have any trouble making it go away.
But as always, it depends on your own situation. Whether you’re facing foreclosure and want to figure out your best option, or if you have already been through foreclosure and you’re worried that your second mortgage is going to rise from the dead and come back to haunt you, get in touch.