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.
Bill says
I own a home that is worth +/- $300,000. I owe $350,000 on a first and $110,000 on the second. I was lucky enough to get a loan modification on the first. I just filed chapter 7 bankruptcy so I have wiped out all my credit card debt. The one thing I have left to take care of is the second loan. It is with Wells Fargo. I have not made a payment in over a 2+ years. I have also not heard from them in over 18 months. What should I do about the second? Wait to hear from the bank? Contact them myself? Try and negotiate a buy out? Do nothing? I want to stay in the house, especially with the terms I got with the loan modification.
Charles says
Bill, to make a solid recommendation one way or the other, I would need more details on your overall financial situation as well as the loan history. In general, my view is that it’s best to settle these mortgage charge-offs, since otherwise they could haunt you throughout the entire Statute of Limitations period and become a nightmare lawsuit down the road. But there are other factors that pertain, such as potential tax impact. Please feel free to request the 20-minute phone consultation over at my other website, http://www.SecondMortgageAdvice.com.
Andy says
I got a different twist…GMAC which holds my first (126K) and second (23K) asked I send $41K certified fund to release the first mortgage (yes the first). The FMV is probably in the 60K range. So I assume there is big tax impact. My questions-1)should I negoitate to get them to also eliminate the second mortgage 2)given I already have an offer should I hire expert to negotiate for me? I don’t want to do that given I lost 3k to firm promising to negotiate for me about two years ago.
Charles says
Andy, regarding tax impact if this is your primary residence then look up the Mortgage Debt Forgiveness Act, which normally applies to cancelled debt on purchase money loans for primary homes. It does not usually pertain to forgiven debt associated with second mortgages or HELOCs, as those are not often purchase money loans, but the usual rules for a insolvency exemption (see IRS Form 982) would apply if you qualify. Yes, you should try to negotiate settlement on the second mortgage, so you don’t have a deficiency hanging over your head. No, you should not hire a “negotiation firm” to handle it, since that will just lead to a repeat of your previous rip-off experience! If you want coaching assistance, please visit my other website at http://www.SecondMortgageAdvice.com and complete the consultation request form.
Jac says
2nd Mtg Settlement
We are unable to maintain both our 1st and 2nd Mtg current on both. We are struggleing to maintain this and are unable to continue with this much longer. We tried for HAMP but did not meet the 31% requirement. 1st mtg reviewing our application for in house mod which does nothing to help us with the 2nd. I contacted our 2nd mtg co to inuire on modifications or trying to settle. GT Servicing (owned by BOA) advised settling and keep current on the payments. She stressed the importance of the hardship letter for us to be considered for a settlement with BOA. This sounds too good to be true and you know what they say…It usually is. Should we try to settle for the 5-10% of the bal owed of $184K on the 2nd while we are still current. Situation is home worth ~$320 owe $272K on first $184K on second of which $50K was a 2nd taken out at the time we purchased to avoid PMI.
Charles says
Jac, I see no harm in trying, but I have yet to see a second mortgage settlement that took place on an account in current standing. In fact, most second mortgage settlements don’t take place until after the account has gone past charge-off (after six months). If you want coaching assistance with this project, please feel free to email me directly at [email protected].