Junior or Second Mortgages in Foreclosure |
Lawyers.comsm
Owners of both residential and commercial properties commonly have more than one loan obligation secured by mortgages against their properties, and foreclosure affects second/junior mortgage lenders, borrowers, and others. The second/junior lender is affected not only when a foreclosure takes place against a single property and borrower, but is impacted on a larger scale, with ramifications on loan originations and the availability of credit.
Not all mortgages against a property are treated equally in a foreclosure -there is a priority in the right to payment from the proceeds from a foreclosure sale. A "first" mortgage is commonly used to finance the purchase of property, and additional mortgages, known as "second" or "junior" mortgages, often for a smaller amount, include familiar loans such as home equity lines of credit (HELOCs) and construction loans. Borrowers often take out second/junior mortgages to access equity in the property, or to provide a portion of the downpayment, e.g., in a situation where the borrower needs to keep the amount of a first mortgage low enough to avoid the requirement of the first mortgage lender for private mortgage insurance, and does not have another downpayment source, such as savings or gift money.
Second or Junior Mortgages in a Foreclosure
The second/junior lender will usually be made a party to the foreclosure action.
There may be a deficiency, or not enough funds to pay off the amounts owed on a second/junior mortgage after the foreclosure sale because the first mortgage and other liens against the property, such as a tax lien, and foreclosure expenses, will be paid first. This is known as the priority for payment to the parties with claims against the property and the borrower.
Generally, the second/junior mortgage is extinguished in foreclosure proceedings, and a second/junior lender will recover little, if anything at all, as seen in the alarming number of foreclosures on residential mortgages where the borrower started with little or no downpayment, and the value of the property remained stagnant or fell.
Options Available to the Junior or Second Lender in Foreclosure
Payment of the amount of the deficiency, or the amount owed on the secondary loan after the foreclosure sale proceeds have been exhausted, can be sought from the borrower by seeking a deficiency judgment, which is a personal judgment against the borrower.
The second/junior lender can buy the property at the foreclosure sale or possibly exercise the right of redemption (essentially pay off the first/superior mortgage).
The second/junior mortgage lender could initiate foreclosure proceedings, but this option still leaves the property subject to loans with higher priority.
Challenge the priority of superior loans, in order to achieve a greater right to payment, but the chance of success is limited.
Affect of Foreclosures on Credit
Foreclosure affects not only the termination of the lending arrangement, but influences the secondary lending process on a wider scale. One need only look to the alarming double, and even triple-digit increases in recent foreclosure rates and the effects can be seen: lenders have tightened the availability of new credit, and some have reduced the credit available under existing mortgages, as in the reduction of the amount available for draw under HELOCs (home equity line of credit). Second or junior lenders could also demand assurances and concessions from senior mortgage holders regarding the payment of their loans in the case of foreclosure as a condition of making credit available to a borrower. Finally, secondary lending practices are subjected to increased regulation, as states pass law regarding HELOCs, subprime lending, and predatory lending practices.