When is Foreclosure Right for You? Part 2 of 2

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.