Reduce Your Mortgage Obligations to Avoid Foreclosure
You may be able to stop paying some of your home loans without risking foreclosure. Here's how.
If you're like many homeowners, your home may be encumbered with a second or third mortgage (or deed of trust), and perhaps a home equity loan. You may be able to avoid foreclosure if you are having trouble making all your mortgage payments, by paying the right loan and either stoping payments or making reduced payments on the rest. In almost every case, your first mortgage or deed of trust is the right loan to keep current.
Although stopping payment of loans secured by your home is usually a last resort, if you can do so safely (that is, without risk of foreclosure), thereby leaving you with more money to pay the one or two lenders that could foreclose on your house, this strategy could keep you in your home. (To learn about other strategies to deal with the threat of foreclosure, see How to Avoid Foreclosure and How Bankruptcy Can Help With Foreclosure.)
Here's how it works.
Mortgages and Foreclosure: The Basics
When you originally took out the loan to buy your home, you agreed to have the loan (or loans) secured by a mortgage or deed of trust. This gives the lender a lien (legal claim) on the property. If you fail to comply with the payment terms of the loan, the lender can enforce its rights by foreclosing on your home. In foreclosure, the lender sells your home in order to recoup the money you owe under the mortgage.
The original loan you used to buy your home is called a "first mortgage." Why first? It's almost always recorded first and gets paid first after a sale. In the same manner, a second loan secured by the home is a second mortgage and is paid second. In addition, many people have other loans against the home, often in the form of a home equity line of credit. As with the first mortgage, the lender's primary remedy for a default on these additional loans is foreclosure.
Who gets what in a foreclosure sale? If the home is sold in foreclosure, the lenders are paid in order of seniority the holder of the first mortgage gets paid first, the holder of the second mortgage gets paid second, and so on. If there isn't enough equity in the home to pay off a second or third mortgage, those lenders go unpaid. As a result, those lenders have no incentive to initiate foreclosure proceedings because they would get nothing at the end of the day. Lacking an incentive, a lender is extremely unlikely to bring a foreclosure action even if your state's law technically allows it.
Bubble Year Mortgages: Loans Without Adequate Equity
Until the last several years, banks would not make loans without good credit and a healthy chunk of equity to secure the loan. In the recent bubble years, however, banks were more willing to extend loans to homeowners without a measurable chunk of equity. Banks did this with the expectation that property values would rise fast enough to provide adequate security for the prospective loan. Also, liberal home appraisals were easy to come by creating equity on paper that might not have actually been there.
The Real Estate Market Crash: Unsecured Home Loans
When the real estate market crashed, home values in many areas of the country stopped appreciating or plummeted, erasing whatever equity there may have been at the time of the loan as well as the hope of equity to come.
What does this mean for homeowners? If there isn't enough equity in your home to cover one or more of your home loans, skipping payments on those loans probably won't result in a foreclosure action.
Does the lender have other remedies? A lender that has an unsecured loan (that is, where the equity doesn't cover the loan) can sue you. If the lender gets a money judgment, it can use a variety of methods to collect the judgment from you, including garnishing wages and levying bank accounts. (For more on collection methods, see Nolo's area on Collecting a Judgment ). It can also put another lien on your home with the idea that your home will develop equity in the future. But none of these collection methods will threaten your home in the near future.
Because lawsuits usually take a long time to develop, during this time period you may be able to raise money from another source to make payments or settle with the lender for less than you owe. (For tips on negotiating with your lender, see How to Avoid Foreclosure.) Bankruptcy may also help handle the threat of judgment enforcement. (For more on bankruptcy, see Nolo's area on Bankruptcy.)
Use this strategy as a last resort. Even if you have home loans that are unsecured, don't stop payments unless you really cannot meet your mortgage obligations. Defaults and money judgments are major negative marks on your credit report. And, as discussed above, the lender can always sue you for a money judgment. But if stopping payments on a second or third mortgage means that you can make payments on the first, and thereby prevent foreclosure, then this strategy is worth considering.
How to Determine if Your Home Loans are Unsecured
To determine whether the loans on your home are secured or unsecured (as a factual matter) begin with your home's value be optimistic, but sensible. Then subtract the amount of the first mortgage. If the result is zero or less, foreclosure is not a viable remedy for the other lenders because there is no equity left in the home to pay them off. If, after subtracting the amount of the first mortgage, there is still equity left, next subtract the amount of the second mortgage. If the result is zero or less, the equity won't pay off a third mortgage.
For example, assume that your home is worth $400,000. You have a first mortgage of $350,000, a second mortgage of $50,000, and a home equity line of credit worth $25,000. When you subtract the first and second mortgages from the home's value, you get zero. There isn't any equity left over to secure your home equity line of credit. So, if you stop making payments on the home equity loan, the lender has no incentive to foreclose it won't get a penny because your equity will pay only the first and second lien holders.
Unfortunately, it's not always that simple. Sometimes a second or third mortgage is partly secured and partly unsecured. (If, in the example above, the second mortgage was $75,000, then $50,000 would be secured and $25,000 would be unsecured.) In that case, a foreclosure by the junior lien holder might recover some of the lien but not all of it.
For more information on dealing with foreclosure, negotiating with lenders, and handling other financial troubles, see Nolo's Bankruptcy and Foreclosure Blog or the bestselling Foreclosure Survival Guide, now available online at no charge. Both are written by practicing attorney Stephen R. Elias, president of the National Bankruptcy Law Project.