This post is not legal advice. It is a general discussion of SOME of the relevant legal issues surrounding foreclosure. If you are considering or facing foreclosure, you need specific legal advice for your particular situation. Consult an attorney in your area.
In my last post, I discussed the difference between a judicial and a nonjudicial foreclosure, which is one of the two essential issues to understand when considering whether to allow your property to go into foreclosure. The other essential issue concerns the number of mortgages you have on the property.
For many reasons, people often took out a first and a second mortgage when they bought property. Others opened up a home equity line of credit which they then used to pay other bills. In either case, the owner has a first and a second mortgage on the property. Where there are two mortgages, foreclosure creates much greater risk.
First, some background: mortgages, like all other liens, are arranged by seniority. (A “lien” is a legal right to force the sale of particular property to repay a debt, whether on a mortgage, unpaid property taxes, an unpaid contractor’s bill, etc.) As a very general rule, seniority is determined by time; the older the lien (i.e. the longer ago it was created or placed on the property), the greater the seniority. The “first” mortgage (or any other lien) — known as “first position” — will be paid in full by the sale of the property before the second and all subsequent liens are paid. The second will be paid in full before the third and all subsequent liens are paid. The third will be paid in full before the fourth, and so on. So, in a market like this one, the only debtor who has any real chance of being repaid in full is the mortgage or other lien in first position.
Where an owner has two mortgages, one is senior to the other (usually in first and second position on the property). Typically, when an owner stops making payments on these mortgages, the first position mortgage will foreclose. By foreclosing, the first position mortgage (under authority created by the deed of trust) forces the sale of the property and the proceeds (after payment of costs) are used to satisfy the debt. If there are any remaining funds (very unlikely in today’s market), they are applied to the second position mortgage and then to the remaining liens in order of priority.
Now, here is the important part: foreclosure extinguishes the debt that is being foreclosed, but it does not extinguish the junior debts (such as a second mortgage). So, if the lender forecloses the first mortgage and the proceeds are insufficient to pay the total amount due, the balance is extinguished as a matter of law (with certain tax implications — perhaps the topic of a future post). In other words, even though the debt was not repaid in full, the debtor is off the hook and does not need to pay the difference on the first mortgage.
However, the debt of the second mortgage survives. Admittedly, the second lender can no longer foreclose on the property because the legal right to do is extinguished by the foreclosure of a senior debt. The problem for the owner, though, is that he still owes the money borrowed under the second mortgage. In WA, you have six years in which to sue for breach of contract. The owner/debtor’s failure to make payments on the second mortgage (per the terms of the promissory note) constitutes a breach of contract. So, after foreclosure of the first, the second lender will have six years in which to sue the debtor for the full amount of the debt. The debtor will probably lose that suit. At the end of that process, the lender will have a judgment against the debtor for the full amount of the balance due, plus interest and late fees, plus attorney’s fees and costs incurred by the suit. Judgments are bad (see Part 1).
So, if you’re thinking about foreclosure, you’re taking a very big risk if you have multiple mortgages. You could get a very, very unpleasant surprise five years later. At that point, bankruptcy may be the only viable option.
Good info. Craig. A good portion of the 80/20 100% financed transactions have the 1st and 2nd mortgage with the same lender. Under those circumstances I would guess that both are extinguished in a foreclosure. I can’t imagine lenders going after homeowners under that scenario. Saddling homeowners with judgments would prolong economic recovery. There are enough folks with judgments already.
Nicely written Craig. I specifically like how you emphasized (in this mkt). This is the KEY going forward for banks to attempt recovery through judgements.
It will be interesting to see that if the market recovers in the next 3 years how hard the banks will pursue judgements, and in turn, the spike in Bankruptcy’s that will result.
I suspect the Bankruptcy Attorney’s will be having their biggest years 2009-2015.
Nicely written Craig. I specifically like how you emphasized (in this mkt). This is the KEY going forward for banks to attempt recovery through judgements.
It will be interesting to see that if the market recovers in the next 3 years how hard the banks will pursue judgements, and in turn, the spike in Bankruptcy’s that will result.
I suspect the Bankruptcy Attorney’s will be having their biggest years 2009-2015.
Tim:
Without providing the link, I will note that Ardell and I (and Kary Krismer and some other commentators) went back and forth on that issue (whether foreclosure of the first also extinguishes the debt of the second where both are held by the same lender). I’ll just say that the consensus among the ATTORNEYS ( 😉 )was that, under those circumstances, the debt of the second WOULD survive and the buyer could be subject to liability for it. Admittedly, the existing case law does not squarely address the issue but there is no legal basis for treating one lender with two mortgages differently than two lenders each with one. So, even if you have two mortgages with the same lender, you’re still at risk of liability on the second following foreclosure of the first.
Your comment about saddling owners with judgments feeds nicely into Ray’s comment — it may be that the process eventually leads to a spike in bankruptcies as a result.
A foreclosure will likely result in the revocation of a government security clearance and the position likely terminated. Armed Forces, CIA, Boeing, government contractors.
Current and future employers may have the right to run credit checks. A foreclosure may prevent a job candidate from obtaining financially sensitive jobs and current employment may be reassigned or terminated.
Great article- I agree with Ray that the bankruptcy attorney’s “best years” are yet to come…
Michael, I view what has happened in this last 5 years and the coming 5-10 years as a reason for a Bankruptcy/Foreclosure. Many were trapped and became victims.
The revocation of Gov’t security clearances, armed forces etc. will be reexamined. These policies will give victims a “pass” if they are truly worthy of such a position.
The sheer numbers will be staggering by the time we are done with this.
Watch for Loan programs being rolled out that will cater to “victims” of foreclosure and watch how easy it will be for post-Bankruptcy citizens to buy again.
Bank on it!
Michael, I view what has happened in this last 5 years and the coming 5-10 years as a reason for a Bankruptcy/Foreclosure. Many were trapped and became victims.
The revocation of Gov’t security clearances, armed forces etc. will be reexamined. These policies will give victims a “pass” if they are truly worthy of such a position.
The sheer numbers will be staggering by the time we are done with this.
Watch for Loan programs being rolled out that will cater to “victims” of foreclosure and watch how easy it will be for post-Bankruptcy citizens to buy again.
Bank on it!
Craig,
Very nicely put. I almost argued with you when you said that foreclosure of the first mortgage does not extinguish the second, junior debt. The second lienholder’s security (mortgage) is in fact wiped out by foreclosure of the first. However, as you nicely noted later in the post, the note is still valid – and thus payment in full remains the responsibility of the homeowner.
I’m a Cincinnati Realtor, and as such I’m not able to give legal advice to my clients. However, if a homeowner I’m talking to has both a first and a second mortgage, and has some financial distress that prevents paying those mortgages, I recommend they speak with a bankruptcy attorney before a foreclosure is effected.
The Cincinnati MLS is literally stuffed with homes in various stages of short sale or foreclosure. Unlike at any time in the past, Realtors need to be educated and knowledgeable about both short sales and the local foreclosure process, if they’re to be truly effective in the current market. This is true whether they’re representing buyers or sellers.
Great blog, thanks.
Bob Wuest
Craig,
Very nicely put. I almost argued with you when you said that foreclosure of the first mortgage does not extinguish the second, junior debt. The second lienholder’s security (mortgage) is in fact wiped out by foreclosure of the first. However, as you nicely noted later in the post, the note is still valid – and thus payment in full remains the responsibility of the homeowner.
I’m a Cincinnati Realtor, and as such I’m not able to give legal advice to my clients. However, if a homeowner I’m talking to has both a first and a second mortgage, and has some financial distress that prevents paying those mortgages, I recommend they speak with a bankruptcy attorney before a foreclosure is effected.
The Cincinnati MLS is literally stuffed with homes in various stages of short sale or foreclosure. Unlike at any time in the past, Realtors need to be educated and knowledgeable about both short sales and the local foreclosure process, if they’re to be truly effective in the current market. This is true whether they’re representing buyers or sellers.
Great blog, thanks.
Bob Wuest
This may sound naive but how would this affect an investor/buyer at a court foreclosure sale? Would the new investor buyer be on the hook for all of the mortgages/liens on the property that came after the first mortgage holders foreclosure was complete? Or do those mortgages/liens become extinquished as far as the new owner is concerned?
Steve — foreclosure, whether judicial or nonjudicial, extinguishes all junior liens. So, the buyer takes free of all junior liens (those created after the lien being foreclosed), but subject to all senior liens (those created prior and a handful of others such as IRS liens which automatically take priority). The former owner, however, remains liable for all debts other than the one being foreclosed.
Craig,
Here is a question for you then, what if you keep the 1st current but quit paying on the 2nd thereby forcing the 2nd to foreclose. So, let’s say the value of the home is such that there is money to adequately pay off the first and then some for the 2nd but not all of the 2nd. Since the 2nd is the one who foreclosed and as you say…”the second lender can no longer foreclose on the property because the legal right to do is extinguished by the foreclosure of a senior debt” and yet the 2nd is the one who foreclosed…is the legal right of the 2nd thereby extinguished since they are the ones to foreclose?
Scott — this is not legal advice. For legal advice, you need to retain an attorney.
To answer the question: Foreclosure of the 2nd — like any foreclosure — would extinguish your ownership interest in the property, and it would also extinguish the debt being foreclosed. Whoever purchased at the auction would take it subject to the 1st. Therefore, the purchaser would either need to pay off the 1st, or the 1st would then foreclose its interest based on the “due on sale” clause. In either event, though, the buyer’s obligation might be satisfied (either extinguished by the foreclosure, or paid in full by the purchaser). There are a lot of moving parts, though, so it seems to me (off the top of my head — all I have time for today) that this result is far from certain.
Scott and Craig,
I still think there is ambiguity when the holder of the first is the same as the holder on the second, and when the loan is a cash out refi taken out subsequent to the purchase mortgage.
Unfortunately, Ardell, and as far as I can recall, you’ve never been able to provide any legal authority for this opinion other than a strained interpretation of one case. Until you do so, I’m afraid I won’t be giving this particular opinion of yours much weight at all.
All the above informed discussion makes me glad I’ve got a hold on another part of the Real Estate business. Jerry
Craig,
VERY GOOD articles, and Part 2 of 2 is exactly what I’m going through right now, except for the fact that my 2nd mortgage is a ‘silent second.’ It doesn’t come due until my townhouse condo is refinanced or sold. I bought at top of market in 4/05, as first time owner at 58 years old, and now my place has lost 35%. The program that was supposed to help people like me, now is hurting me in this time of economic woes.
Both mortgages has a clause that includes the mortgage holder as having “power of sale.” The ‘silent second’ mortgage program also has what looks like a separate promissory note.
The real issue for me is that I’ve come down with a health issue, and climbing stairs is not as comforable as it used to be, and could surely use a one level/floor place to live. For sure I won’t be able to sell my unit any time soon, and the 2nd mortgage does not allow me to rent out my unit, or they will foreclose on me.
Is there any hope in this type of situation?
Craig,
VERY GOOD articles, and Part 2 of 2 is exactly what I’m going through right now, except for the fact that my 2nd mortgage is a ‘silent second.’ It doesn’t come due until my townhouse condo is refinanced or sold. I bought at top of market in 4/05, as first time owner at 58 years old, and now my place has lost 35%. The program that was supposed to help people like me, now is hurting me in this time of economic woes.
Both mortgages has a clause that includes the mortgage holder as having “power of sale.” The ‘silent second’ mortgage program also has what looks like a separate promissory note.
The real issue for me is that I’ve come down with a health issue, and climbing stairs is not as comforable as it used to be, and could surely use a one level/floor place to live. For sure I won’t be able to sell my unit any time soon, and the 2nd mortgage does not allow me to rent out my unit, or they will foreclose on me.
Is there any hope in this type of situation?
Theresa — this is not legal advice. For legal advice, consult an attorney in your area in person, not via a blog.
That said, I suggest you confer with the bank’s workout department to see if some type of modification is possible given your hardship. Bet of luck.
Well written article, thank you for posting. My husband and I are in a similar position in that we have two mortgages. In December 2009, we stopped making our payments and listed our house (for less than we owe). We have been in contact with our lenders numerous times prior to December with no luck on a modification, it seems that “first” lenders don’t count “second” lenders as a part of the whole mortgage. We certainly can’t refinance with current market values and especially now that we are behind on payments. While we are taking full responsibility for our situation, I am feeling frustrated at the lack of help out there for folks like us. Bankruptcy seems imminent.
On a related issue, my husband is the only one listed on our mortgages. It seems that when we purchased, due to my lack of income, I was not listed as a person responsible for the debt. I am however, listed on our tax statements and all other documents pertaining to the house. Upon foreclosure, how will this impact me and what I am liable for now and in the future? If bankruptcy turns out to be our last option, will both my husband and I need to claim or can we possibly salvage some sort of credit on my end?
As with all of the others… Is there any hope out there? Thanks in advance!
Well written article, thank you for posting. My husband and I are in a similar position in that we have two mortgages. In December 2009, we stopped making our payments and listed our house (for less than we owe). We have been in contact with our lenders numerous times prior to December with no luck on a modification, it seems that “first” lenders don’t count “second” lenders as a part of the whole mortgage. We certainly can’t refinance with current market values and especially now that we are behind on payments. While we are taking full responsibility for our situation, I am feeling frustrated at the lack of help out there for folks like us. Bankruptcy seems imminent.
On a related issue, my husband is the only one listed on our mortgages. It seems that when we purchased, due to my lack of income, I was not listed as a person responsible for the debt. I am however, listed on our tax statements and all other documents pertaining to the house. Upon foreclosure, how will this impact me and what I am liable for now and in the future? If bankruptcy turns out to be our last option, will both my husband and I need to claim or can we possibly salvage some sort of credit on my end?
As with all of the others… Is there any hope out there? Thanks in advance!
Shelley — as you may know, I don’t practice law via a blog. I suggest you consult an attorney, in person, about these issues (although the attorney won’t necessarily have insight into the credit issue). In particular, if you are insolvent and/or want to keep the house notwithstanding your current difficulties, you should consult a bankruptcy attorney. Give me a call if you are in WA and would like a reference. Alternatively, I know there are some attorneys who offer a flat fee for consultation with a distressed homeowner.
Best of luck.
Shelley — as you may know, I don’t practice law via a blog. I suggest you consult an attorney, in person, about these issues (although the attorney won’t necessarily have insight into the credit issue). In particular, if you are insolvent and/or want to keep the house notwithstanding your current difficulties, you should consult a bankruptcy attorney. Give me a call if you are in WA and would like a reference. Alternatively, I know there are some attorneys who offer a flat fee for consultation with a distressed homeowner.
Best of luck.