I recently received the following question from a reader of my Atlanta bankruptcy law web site:
I live in Georgia. If my 1st mortgage goes to foreclosure, what happens to my second mortgage?
Here are my thoughts: if the holder of a first (or senior) mortgage forecloses, all junior mortgage liens are wiped out. However, that does not mean that the debt goes away – it just means that the first lender gets the property free of the junior claims. The junior lender no longer has the property as security, but the second mortgage lender can still try to collect from you.
Holders of defaulted second mortgage notes are often very aggressive, but they also know that their chances of collection are limited. After all, if you couldn’t pay to keep your home, how much money are you likely to have to pay another debt? They also know that they will get nothing if you declare bankruptcy. This means that you can often settle for 10% to 30% of the debt. Keep in mind that the creditor in all likelihood is an investor who bought bundles of notes from failed financial institutions, paying pennies on the dollar.
Speaking of failed financial institutions, during the go-go days that ended abruptly in 2008, some lenders (such as Lehman Brothers) were providing 100% financing to homeowners and investors, usually by making two loans, one for 80% of the purchase price and the other for the remaining 20%. These loans were then immediately bundled together and sold off to Wall Street investors in the form of mortgage-backed securities.
In Georgia, after a foreclosure sale is held, the foreclosing lender cannot pursue the borrower for a deficiency unless it goes through a two-step process, involving a confirmation hearing and then a lawsuit. Lenders rarely pursue confirmation because it is not economically feasible, although we are seeing confirmation hearings more and more as property values decline.
The second lender, however, would not need to obtain authorization from a Superior Court judge to pursue its claim, since the second lender would be suing under the terms of a defaulted promissory note.
Georgia has special rules for 2nd mortgage borrowers where the first and second mortgage lenders are the same company.
If you are one of the many people who financed the purchase of their homes with two loans, say one for 80% of the purchase price and the other for 20%, you may benefit from several decisions by the Georgia Court of Appeals, which has held that where two loans are from the same lender, closed at the same time, as part of the same purchase transaction and secured by the same property, they are “inextricably intertwined,” meaning that the two debts are legally merged into one for purposes of the confirmation law. This means that unless there was a confirmation hearing held within thirty days of the first foreclosure the lender can’t sue to collect on the second mortgage note.
The obligation to the second mortgage holder is in a sort of legal limbo, since it’s not extinguished, but the lender can’t take any action to collect, although it may damage your credit score. This has some interesting legal implications, but that is a discussion for another time and place. The bottom line for you is this: Even if the lender can’t collect the debt, if you do end up filing bankruptcy, you should list the debt in your petition.
Jonathan Ginsberg, Esq.
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Last modified: November 10, 2010