There is a “hidden” component to the real estate and financial crisis, and it gets very little attention by the media. I’m referring to the problem with second mortgages on homes that have lost market value during the real estate crash. Banks are being allowed by the Treasury Department to keep large portfolios of second-lien mortgages on their books at values close to those before the bubble burst.
Some estimates indicate that up to 50% of at-risk properties include this type of loan, so it’s a huge problem. There are more than $1 trillion in outstanding second-mortgage loans, with more than 40% of that concentrated among the four largest lenders. With housing prices down more than 30% average since 2006, many of these second liens are either completely without equity as collateral, or very close to it. Today, the major banks are carrying these notes at 86-93% of book value, when some estimates indicate that they are actually worth only 40-60 cents on the dollar on average.
Many consumers are unaware that it’s often possible to settle with creditors on second mortgage obligations for greatly reduced principal balances. Why would a second lender agree to a settlement on a debt that is secured? Simple. Once the property drops in value below the level where even the first mortgage is under water, then the second lender is completely exposed and is very unlikely to recover anything by way of foreclosure. In that situation, a settlement for even 10-15% of the face value on the mortgage often makes sense for the lender.
For example, let’s say you purchased a home for $300,000, with $30,000 down payment and a first mortgage of $270,000. Later the property appreciated in value $400,000 when the market was at its peak. Like so many Americans, you borrowed against the increased home value and took out a home equity line of credit (HELOC). With the home valued at $400,000 against a mortgage of $270,000, you had $130,000 of equity to work with. Being prudent, you didn’t borrow all of that, only $100,000. So you had a first of $270,000 and a HELOC for $100,000. Then the real estate crash happened. Your $400,000 house is now worth only $250,000, less than you originally paid for it. This means that the first mortgage of $270,000 is itself under water, since the house would sell for less than you owe on the loan. And therefore the second lien is 100% exposed. There is no collateral at all remaining to cover this note. In practical terms, this type of obligation can be settled the way any unsecured debt (like a credit card account) can be settled.
At ZipDebt, we’ve been assisting some of our clients to settle second mortgages, and the results have been nothing short of amazing. We’re seeing 10-15% settlements routinely, even less in some cases. But it’s important to understand that not all second mortgages can be settled, nor is it appropriate to use this strategy in all cases where the property is distressed. Sometimes there are other solutions more appropriate to the specific situation. It really requires a detailed analysis to determine whether a second mortgage or HELOC is suitable for the settlement approach. There are a number of key factors involved, such as whether the home is primary or a rental property, whether the state the property is located in is a “recourse” or “non-recourse” state, the specific type of mortgage contract involved, and of course, the equity figures relative to loan face values.
UPDATE: April 5, 2012
As of April 2012 we are offering PAID CONSULTATIONS ONLY on second mortgages or HELOCs, and no longer offer free consultations on this subject. Our fee is only $150, and includes 30 days of follow-up support via email. We made this change because our experience has been that each mortgage situation is totally unique, and requires careful analysis and discussion before a solid recommendation on strategy can be made. We have had so many inquiries on the topic of second mortgage or HELOC settlement, that we felt a paid consultation would be the most efficient method of assisting consumers to avoid scams and make the correct strategic decision. For additional details, please visit our other website at SecondMortgageAdvice.com.
UPDATE NOVEMBER 26, 2012:
Gerri Detweiler of Credit.com recently interviewed me on Talk Credit Radio on the subject of second mortgage and HELOC settlements. This is an in-depth podcast that covers a lot of important information consumers need to know on this topic. If you’d like to learn more about debt settlement as it pertains to mortgages or HELOCs, this is the audio file you’ve been hunting for! Click here to download the full podcast free of charge.
Hello, I have a second loan , they are now calling it a home equity loan , but when i refinanced in 2006 it was a mortgage taken out , by a shady broker so i had a refinance , and got a new mortgage, lender now says its a homeequity loan it was for $97k now paid down $91k, they are reporting it on my credit report as 2 yrs at $531.87 a month, I am in the process of a second lien 2my modification, what do you think this reporting means on the credit report. This loan was more fraud than predatory, I just dont understand how it can be a homeequity loan because I did not take a lump sum of money on it . Please explain if you can, I would be most greatful……
Mary, I can’t quite tell what has happened here just based on the information you have given. Please feel free to email me at [email protected] and I’ll try to help you figure out what you need to do.
Is negotiation still possible if the same bank holds both the first and second mortgage?
Mike, yes, it is possible to negotiate a principal balance on the second when the first is held by the same lender. It all depends on the relative values between the notes and the current market value of the property.
My 2nd mortgage lender Litton offered 10% of the entire loan to assist in settlement. If I accept the offer they will write the lien off credit but will they send a 1099 to IRS and make me pay on the remainder of the loan?
Karen, if the lender issues a 1099-C that means they have canceled the remaining amount. Assuming everything is documented correctly, the settlement should extinguish the lien and the deficiency at the same time. The 1099-C pertains to taxes, not repayment of the debt itself. Generally speaking, the Mortgage Debt Forgiveness Act of 2007 (extended to 2012) does not apply to second mortgages, since most second mortgages were not used to substantially improve the property. However, the standard insolvency exemption for canceled debt would still apply, so if you are insolvent at the time you settle, you may be eligible to exclude the 1099 from income.