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.
Here is my situation. I live in Arizona (a non recourse state) I owe 154,000 on 1st mortgage through Wells Fargo. I have a HELOC that was non-purchase money of 28,000 through Bank of America which is using the property as the collateral (loan docs state “deed in trust”.
My house is currently worth around 70k so I am 100% underwater. I decided to do a strategic default and stopped making payments to my first in June of 2011. I continued to make payments to the HELOC and am still current.
Wells Fargo proceeded with the foreclosure process and my house is now due to be auctioned off April 4th.
I was just contacted by a short sell realtor that swears she can get my bank to agree to a short sale and also to settle or write off the HELOC as well. Is this realistic with 1 month until auction? Will Bank of America settle my 2nd even though my financials will show that I can afford the payments and I am a “strategic” defaulter?
John, if the HELOC is not purchase-money, then it doesn’t matter that AZ is a non-recourse state — BOA could still pursue you for the deficiency balance. After reviewing your financials, BOA will probably work with the realtor to help close the sale by releasing the lien (probably in exchange for a few thousand from the first lender), but my best guess is that they will resist waiving their right to pursue you for the deficiency balance. If the home is scheduled for auction, why bother with the short sale? It might make more sense to submit a settlement offer to BOA after foreclosure, when the lien is gone and there is only the deficiency balance to be resolved. On the other hand, if the realtor has a buyer ready to submit an offer, there’s little harm in seeing what happens!
Well I understand a short sale is better then a foreclosure for credit reporting. You can also qualify for a new FHA loan 3 years earlier then if you have a foreclosure.
I talked to the short sale broker today and within hours of her leaving, I received two calls from realtors who had investors that wanted to see the property. I couldn’t believe it!
The other advantage is that the short sale broker told me that they only negotiate short sales where the home owner (me) will be released of all debts and obligations period. They will negotiate with the 2nd mortgage holder so that I play them only a percentage of what I owe…and the first mortgage holder will also pay them a few thousand as you mentioned.
My rental property is worth $350K and I owe $372K on the first and $148k on heloc(recourse loan took money out) property is in CA. I pay $700 out of pocket every month and can’t afford to keep doing it. Heloc is with BOA, since it is a recourse loan, would BOA settle with me and let me off the hook? I am current on both sofar. What are my options? Any help is greatly appreciated. Thank you so much.
Riya, a settlement approach might work in this situation, since the property is worth less than you owe on the first mortgage alone. Another option is a short sale on the property with help from a local realtor.