Sunday, April 21, 2013

What Happens to a Second Mortgage During and After Foreclosure?

If you own a home and find yourself in a financial bind, taking out a second mortgage can alleviate your money woes. Granted, that home equity loan or HELOC (we're going to lump HELOCs into the "second
Do you really need that second mortgage?
mortgage" category for simplicity's sake) will cost you the equity you worked so hard to build, but most people end up selling their homes long before they pay off that 30-year mortgage anyway. While beneficial under the right circumstances, your second mortgage loan becomes a serious complication should your home fall into foreclosure.

Second Mortgages, Liens and the Foreclosure Process

When you take out a first mortgage, you must use your home as collateral. Your first mortgage lender attaches a lien to your property preventing you from selling the home without paying off your debt in full. The same is true for home equity loans or lines of credit. Because your home serves as the security interest for the debt, both lenders hold valid real estate liens and either lender can initiate foreclosure proceedings when you default on its loan.

During a foreclosure, loans are paid in order of priority. The first mortgage lender gets paid first because it filed its lien first. Any other lien holders are paid in the order their liens were filed – including the second mortgage lender. It often happens, however, that the home doesn't sell for enough money to pay off all of the liens the home carries – leaving some lien holders unpaid. To make matters even worse for junior lien holders, a first mortgage foreclosure wipes out all junior liens. Thus, your second mortgage lender could end up losing its security interest – your home – and getting no proceeds from the foreclosure sale.

Your Responsibility for Paying a Second Mortgage After Foreclosure 

After your first mortgage lender forecloses, your second mortgage lender's security interest – its real estate lien – no longer exists. Unfortunately for you, your contract with the second mortgage lender is still valid. You still owe that home equity loan or HELOC, and the lender isn't going to just forget about it and let you waltz away into the sunset debt-free. Not a chance.

All banks policies differ, and your second mortgage lender may allow you to continue making payments on your loan. This scenario is more likely if you continued paying your second mortgage when your first one fell into default and, eventually, into foreclosure. If you defaulted on your second mortgage along with the first, however, the lender may not give you the chance to pony up the dough voluntarily. It may just sue you.

Consequences of Second Mortgage Debt Lawsuit

Mortgage companies are not collection agencies. I advocate fighting collection agencies in court because they are sloppy, unorganized and often have no paperwork to back up outrageous financial claims. This is not the case with mortgage lenders. If a mortgage company sues you, you aren't likely to come out on top.
Stopped paying? Get ready for a lawsuit 

When the second mortgage lender wins its lawsuit, the court gives the company a civil judgment. Armed with a civil judgment, the lender can levy your bank accounts, garnish your wages, seize certain items of personal property and attach liens to other property you own, such a a car or second home. Even worse, the judgment itself is a public record. It appears on your credit report and can devastate your credit scores. Unlike most other negative credit report entries which only remain on your credit report for seven years, civil judgments stick around for the same amount of time that they are enforceable. Depending on the state you live in, a post-foreclosure civil judgment could stick around for a decade or more.

Statute of Limitations for Second Mortgage Lawsuit

Your lender knows that your finances are shot immediately after a foreclosure. Trying to collect from you at this point would likely be futile. You clearly don't have the assets to pay the debt because, if you did, you wouldn't have lost your home. Bank reserves are also at an all-time low immediately after foreclosure.

Does this stop the second mortgage lender from suing you? Absolutely not. It just stops the lender from suing you immediately  The lender wants to collect your defaulted loan balance, and the best way to do that is to hang back and give you the opportunity to get back on your feet financially before snatching the rug out from under you.

How thoughtful.

Every state, however, has a statute of limitations after which you have an airtight defense against your mortgage lender in court. Should the lender sue after the statute of limitations expires, it cannot obtain a judgment against you if you use the expired SOL as a defense in court. At this point, it doesn't matter if you owe the debt or not. All that matters is that the debt is too old and the creditor cannot take legal action past this point.

I'd like to think the lesson in our little cautionary tale is simply this: Avoid second mortgages. Just say no to HELOCs and home equity loans. Run, run, run from using your home to acquire even more debt for things you property don't need in the first place lest your efforts end with a foreclosure.

Related Articles:

Collection Lawsuit Statute of Limitations By State

Make Yourself Judgment Proof

Funds Exempt From Bank Account Garnishment

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