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.
Brandon says
My wife and I may be interested in utilizing your services, but want to know if it is worthwhile first. My wife purchased a home in 2007. It went through foreclosure and was sold in Feb 2012.
Is it possible to settle a HELOC after a foreclosure sale has taken place? We live in Washington State. The 2nd is through Wells Fargo in the amount of $40,000. She has received a complaint and summons from a collection agency with 20 days to respond. I assume they own the debt, but think it would be easier to deal with Wells Fargo instead if possible.
Charles says
Brandon, yes, it’s possible to settle a HELOC after foreclosure. However, if you are already being sued by the creditor, then it’s too late to negotiate directly with them. You need to do your haggling with the law firm instead. It may have been sold, but more likely WF still owns it and is litigating the deficiency claim through an assigned law firm.
Neal says
I have an 80/20 held by BOA. They have served foreclosure papers on us today. The plaintiff is listed as BOA and my wife and I, along with BOA are lsited as defendants. They also Specifically Waive Deficiency. DOes thsi include the second as well, or because they listed themselves as defendants for the second, does the deficiency waiver only apply to the first. Thank you!
Charles says
Neal, I’m not an attorney, so I can’t comment on an active legal matter. Please get in touch with a foreclosure defense attorney located in your area for state-specific advice on dealing with this situation.
Ashok says
Charles, In conjunction to your reply, as per the Zillow the house is priced at 273K and we owe 275K on our first. Also my first mortgage which was modified is not under HAMP, and I realize reading few forums that my first mortgage should have been modified under HAMP in order to qualify under “2MP” for the second. Both loans as of now are current, Going forward If I stop my making payment on second to get attention of the bank to consider for settlement. If it takes a year time from now and if my first mortgage is still around the border I owe, what could be the repercussion ?
Again thank you for your time and appreciate your suggestions.
Thanks
Ashok
Charles says
Ashok, in many states it’s unusual to see a second lender proceed with foreclosure unless there is recoverable equity. There are costs associated with foreclosure, so $273k value versus $275k loan balance is basically a wash against the first mortgage, leaving the second underwater. The repercussions of an aggressive settlement strategy include (a) serious damage to credit score, (b) possible taxable event (there are some exemptions available if you qualify), (c) technical risk of foreclosure (which would be more of a risk if the property starts to increase in value again), and (d) the possibility of a lawsuit for breach of contract. We have not seen a pattern of (c) or (d) happening consistently with most major lenders, but this may change in the future.