This question has been bouncing around in my head for the last six months. The question stems from the problem most underwater California homeowners have: they are personally liable for their second mortgages because they are not PURCHASE MONEY LOANS. They want to let it go in foreclosure, but they will be liable to the second mortgage company for any deficiency after the foreclosure sale.
So how do you get out of it? It’s a question I get every day. The Answer is: GET THE SECOND TO FORECLOSE. If the second, and not the first mortgage foreclose, THE ONE ACTION RULE says they cannot sue you for any deficiency or shortfall after the foreclosure. The first mortgage will be paid in full.
BUT WHAT IF THE SECOND MORTGAGE DOES NOT FORECLOSE? This is GOOD because the FIRST ACTION rule will prevent the second mortgage from suing you until after they foreclose. This means you get to stay in your house as long as you can make your first mortgage payment but you don’t have to make your second mortgage payment. But note: THE SECOND MORTGAGE WILL EVENTUALLY FORECLOSE when you pay down your first mortgage enough or the value of your home goes back up above the balance of the first mortgage.
Now let’s talk about all the BAD THINGS that could happen.
1. YOU ARE NOT ABLE TO MAKE THE FIRST MORTAGE PAYMENT. This is a real disaster. You will be in the same place as before except you will owe the second mortgage for all the unpaid interest and garbage fees they tacked on. DON’T LET THIS HAPPEN. If there is any chance you might not be able to make the first mortgage payments, this is not for you.
2. YOU WILL WRECK YOUR CREDIT for as long as you don’t pay your second mortgage, plus seven years. This is worse than walking away now because your credit will only take a hit for the bad mortgage from the date of the foreclosure plus seven years.
3. YOU WILL NEVER HAVE ANY EQUITY IN YOUR HOUSE. The second mortgage will increase by the amount of the interest rate plus all the penalties and garbage fees they tack on. AND THEY WILL TACK ON A LOT!!
4. When the second eventually forecloses because the house has grown in value and/or you have paid the first mortgage down, YOU MAY HAVE INCOME FROM THE CANCELLATION OF DEBT that is greater than the amount that you would have if you let it go now because the second mortgage has grown by the interest you have not been paying. This could be significant! What’s worse, you will not control the timing of this taxable income. It will happen when the second decides to foreclose so your ability to manage this problem is out of your hands.
5. YOU WILL LIVE IN FEAR OF FORECLOSURE. This might be the worst thing. You will always know the second could foreclose at any time. You will have an idea when this will happen because you it will be when the FMV of your home is in excess of the first mortgage by enough to make it worth foreclosing to the second mortgage lender. Once they issue a notice of default and 60 days has passed, they can issue a notice of sale and foreclose in 21 days!!!, So you will need to be prepared to move once your home’s value stats to go above the first mortgage balance.
6. You will be harassed by the second mortgage debt collectors. This is a manageable problem. Just send them letters telling them you refuse to pay it and that they are not to contact you anywhere. Better yet, pay me to send them a letter. If they continue to contact you, you have a RFDCPA lawsuit against them.
So who should do this? This strategy is best suited for people who are personally liable for their second mortgages and have enough equity to induce the second to foreclose. How much is that? I can’t say, but second mortgage lenders are watching their equity slip away every day so they may act to protect whatever equity they have and foreclose. If they do, the homeowner can walk away without personal liability (but probably a tax bill).
A twist on this strategy is to stop paying your property taxes and homeowners association dues too. I DO NOT RECOMMEND THIS. While these amounts are often paid in the foreclosure process, you remain personally liable for them. That means you can be sued for non-payment. The first mortgage can also pay them and foreclose for non-payment.
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Last modified: December 10, 2007