Many people out a mortgage loan (a first mortgage) to buy their home. Sometimes, homebuyers take out a second mortgage simultaneously with the first one. But a second mortgage could happen later, based on the equity in the home. (“Equity” is the value of your home minus any debt you owe. Think of equity as the portion of your home you own, which is why a lender would be willing to make another loan on a house with a mortgage.)
Like a first mortgage, a second mortgage is a loan that uses your home as collateral. If you don’t make the payments on your second mortgage, the lender can foreclose.
Whether the lender will foreclose depends mainly on how much your home is worth. If your home is worth more than you owe on the first mortgage, the more likely it is that the second mortgage lender will foreclose if you stop making payments on that loan.
What Happens With a First Mortgage in a Foreclosure?
Generally, the date a mortgage is recorded in the county property records determines lien priority. An old common-law principle explains this idea: “first in time, first in right.” A second mortgage is a junior lien.
So, the first mortgage, or senior lien, takes priority in a foreclosure. The proceeds of any foreclosure sale will first go to the senior lienholder, and only the remaining funds will go towards paying any junior lienholders.
While a junior lienholder can start a foreclosure—say if you stop making payments on a home equity loan—the senior lienholder (the first mortgage) still has priority. The junior lienholder (again, say the home equity lender) would have to pay off the entire first mortgage. Or it will have to foreclose subject to the first mortgage.
So, a junior lienholder will usually only foreclose if your home is worth enough to cover the first mortgage and all or part of the second.
Will My Second Mortgage Lender Foreclose?
The more your home is worth, the more likely the junior lienholder will foreclose if you stop making payments. For instance, if your home is worth more than you still owe on your first mortgage, the second mortgage is at least partially secured. So, the proceeds from a foreclosure sale will probably pay off the second mortgage partially or fully. This means it’s probably worth the time, effort, and expense for the second mortgage lender to foreclose.
However, borrowers who default on their mortgage payments are often “underwater” (the home is worth less than what's owed on the first mortgage). So, second mortgage foreclosures aren’t all that common.
If your home is underwater, it’s unlikely a junior lienholder will foreclose; it just wouldn't make sense financially. So, they’ll probably pursue other ways to collect from you, like filing a personal lawsuit to get a money judgment against you.
How Lawsuits for Money Judgments Work
After a first mortgage lender forecloses, you might think your second mortgage will also go away. However, while the foreclosure will wipe out the second mortgage lender’s lien, the debt remains. Home loans usually have two main agreements: a promissory note and a mortgage. While the mortgage gives the lender the right to foreclose if you don’t pay the debt, the promissory note allows it to sue you personally if you don’t repay the loan.
You Might Face a Personal Lawsuit After a First Mortgage Foreclosure
Say you're behind on both your first and second mortgage payments. The first mortgage lender will probably start a foreclosure. A first mortgage foreclosure eliminates junior liens, like a second mortgage lien.
But, if allowed by state law, a second mortgage lender might sue you after a first mortgage foreclosure for whatever money it didn’t receive from that foreclosure. The laws on how and when a junior lienholder can sue you personally for the debt varies by state, so it is crucial to understand your local rules.
You Could Face a Personal Lawsuit Instead of a Foreclosure
Say you're up to date on your first mortgage payments but fall behind on the payments for the second. When it isn’t in the second lienholder's interest to foreclose (like if you're underwater), if allowed by state law, it might instead sue you based on the promissory note to get a personal judgment against you. Again, the laws on how and when a junior lienholder can sue you personally for the debt vary from state to state, so it's vital to know the laws in your area.
If a junior lienholder sues you and wins a money judgment, it can be collected in several ways. A few standard methods for collecting on a judgment are garnishing wages, levying a bank account, or even attaching a new lien on some other property you own. The debt will follow you until you pay off the debt, get a bankruptcy discharge, or somehow settle with the lender.
How to Avoid Foreclosure or Personal Lawsuit
To avoid a foreclosure or a personal lawsuit by a second mortgage lender, here are a few options to consider to resolve your second mortgage debt. (These alternatives can apply to first mortgages, too.)
Offer to Settle the Debt
Your lender might accept a one-time, lump-sum payment that’s less than you owe. But settlements usually only come into play if you’re underwater. If the lender knows it won’t get anything (or much) from a foreclosure, it will probably be more willing to accept a smaller amount to settle the debt. That way, it doesn’t have to go to the trouble of filing a lawsuit for a personal judgment and trying to collect from you.
If the lender does agree to settle the debt, be aware that settled (“canceled”) debt is ordinarily considered income for tax purposes unless you qualify for an exclusion or exception.
Work Out a Loan Modification
If you want to keep your home, you could ask your mortgage lender for a loan modification. A modification permanently changes your loan terms, often by lowering the interest rate, converting a variable interest rate to a fixed rate, or extending the loan term so that your monthly payments will be more affordable.
Ask for a Short Sale
If your first mortgage is underwater and you’re behind in payments, a short sale might be a good way to avoid a foreclosure. A short sale could potentially also resolve your second mortgage’s delinquency. As the name suggests, a “short sale” is when the lender allows the borrower to pay off the loan by selling the property for less than the outstanding debt. The lender accepts the "short" payment to satisfy the debt and discharge the mortgage.
Getting one lender to agree to a short sale is hard enough, but the process is even more difficult with two lenders to negotiate with. Every lienholder must agree to the short sale, so if you’re underwater on both of your mortgages, it is unlikely that a junior lienholder will sign off on the deal. Still, sometimes a first mortgage lender will agree to give some of its proceeds from a short sale to the second-mortgage lender to avoid foreclosing.
While a short sale might help you avoid a foreclosure, you could still face a lawsuit for a money judgment afterward unless both lenders agree to waive the deficiency. (The difference between the short sale proceeds and your mortgage debt is called a “deficiency.” Unless prohibited by law or the short sale agreement, the lender might file a lawsuit seeking a personal judgment, called a “deficiency judgment,” against you for this difference.)
Again, you might have tax consequences if a lender cancels some of your debt.
Consider Bankruptcy
Filing for bankruptcy might reduce or eliminate your mortgage debt, depending on the circumstances. Talk to a bankruptcy lawyer to determine if bankruptcy might suit your situation.
What About Zombie Second Mortgages?
During the foreclosure crisis, many lenders stopped trying to collect on defaulted second mortgages. Often, homeowners stopped receiving statements for these mortgages and mistakenly thought the debt was forgiven or resolved. Now, these "zombie" mortgages are coming back to life and lenders are trying to collect on these old debts.
If a lender seeks payment from you or threatens foreclosure on a zombie second mortgage, you might have a defense such as:
- the statute of limitations has expired
- the lender doesn't have standing (the right to foreclose)
- a violation of state foreclosure laws
- the creditor (or a collector) used abusive, unfair, or deceptive collection practices, which are illegal under the federal FDCPA or state fair debt collection laws
- the lender violated the Real Estate Settlement Procedures Act (RESPA) (Regulation X) or the Truth in Lending Act (TILA) (Regulation Z), such as by failing to send periodic statements, or
- the lender violated state unfair and deceptive practices laws.
Also, state law might provide you with additional protections against a zombie second mortgage foreclosure. California, Ohio, Virginia, and Connecticut, for example, have laws addressing zombie second mortgage foreclosure procedures and notices.
Getting Help With a Delinquent Second Mortgage
If you're behind on the payments for a second mortgage and have questions about what's likely to happen in your specific situation, consider talking to a foreclosure attorney to find out what will happen to those liens and learn about various options in your particular circumstances.
Also, make an appointment to talk to a (free) HUD-approved housing counselor to learn more about alternatives to foreclosure.