How Does Foreclosure Affect a 2nd Mortgage?


How Does Foreclosure Affect a 2nd Mortgage? thumbnail

A second mortgage is also known as a junior lien. The senior lien on a property is more commonly known as the first mortgage. Junior liens are most common on conventional mortgages but can also be a home equity loan or second mortgage on a property used to finance large expenses or home improvements. There are specific rules that apply to second mortgages or junior liens, when a property is foreclosed on.

Position

    The most important point of note on a second mortgage in foreclosure is the party initiating the foreclosure process. In most scenarios the senior lien holder, or first mortgage holder, will be the one who initiates the foreclosure, since the balance owed to the first lien holder is typically much higher than the balance owed to the second.

    While it is not unheard of for the second mortgage holder to file a foreclosure, it is much less common. In foreclosure proceedings, the first lien holder will typically file the foreclosure first, giving them first position in collecting a balance owed after a foreclosure sale.

Foreclosure Sale

    The first lien holder, when holding first position in a foreclosure auction, is only concerned with collecting the balance owed to them. Because of this, when the first lien holder initiates the foreclosure proceedings, the balance owed to the second mortgage is overlooked. This means amount owed to the second mortgage holder becomes null and void, and can wipe out the balance during the auction on the court house steps, and the second mortgage holder collects nothing.

    However, if the second lien holder is the one initiating foreclosure proceedings, the reverse is not true. The second lien holder has a responsibility to pay some of the proceeds of a foreclosure sale to the primary lien holder on the property after a successful foreclosure auction.

Deficiency Judgments

    When a property is foreclosed on and the bank is unable to net the balance owed during a foreclosure auction or completed sale as a real estate owned (bank owned) property, the lien holder can file a deficiency judgment against the owner. This judgment is the difference between the total amount that the bank has collected for a sale of the property and what the individual owes on the mortgage balance.

    Should the junior lien be wiped out when the primary mortgage holder is the one filing foreclosure proceedings, it has an option to file a deficiency judgment against the previous owner for the balance of the loan. This judgment will remain on the previous owner’s credit report for 10 years and can prevent them from financing major items, such as cars or another property.

Prevention/Solution

    Since most lenders know that foreclosure proceedings are costly and that they are most likely to take a loss on the amount owed to them at a foreclosure auction or sale after the fact, lenders are willing to work with homeowners to prevent foreclosure proceedings. This is true of the primary and the second lien holders.

    In the event that the homeowner has suffered a temporary setback due to medical issues or temporary loss of income, the primary and secondary lenders will attempt to achieve a program to work with the owner and bring their payments current. This requires work on the part of the homeowner to contact both lenders and devise a solution to prevent further foreclosure proceedings.

    In the event that the homeowner does not have the means to maintain rights to the property due to more long-term setbacks, such as disability or permanent loss of income, the primary and secondary lien holders will often agree to a short sale. In this scenario, the lenders agree to settle with the owner upon a completed sale of the property for less than what they owe. In the case of a second mortgage, this can be as little as pennies on the dollar, since they run the risk of collecting nothing should foreclosure proceedings be successful.

Expert Insight

    Foreclosure proceedings and rights for consumers vary from state to state. For homeowners facing foreclosure from a primary lender or secondary mortgage holder, the advice of legal counsel is crucial to negotiating the position. In many cases consulting a bankruptcy attorney will provide the owner with options for a temporary stay on foreclosure proceedings, and can provide advice on how to stay in the home.

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