What Happens to a Second Mortgage in a Home Foreclosure?

The homeowner often takes out more than one mortgage on his home. Once the first mortgage lender forecloses on the property, the lender will sell the mortgage to the highest bidder in a foreclosure auction sale. The sale proceeds will be used to pay down any real estate taxes due. After the real estate taxes are paid, if any funds are left, the first loan must be paid, followed by the second mortgage debt. However, the auction proceeds might not be enough to cover these debts.

Insufficient Funds to Pay First & Second Mortgage Lenders

If the balances in the first and second loans cannot be paid off, both lenders have the right to sue the borrower for balances owed, plus interest and other costs. If both lenders sue the borrower and win, each will be granted a “deficiency judgment”. Such a judgment will give both lenders the legal right to garnish the borrower’s wages, seize bank accounts, and place a levy against other property not exempted by state law. However, not all states allow deficiency judgments. In that case, the lender’s rights to proceed against the borrower are terminated once the property is foreclosed upon. The lender may not pursue further collection activity.

Second Mortgage Holder Buys Back the Property

When the first mortgage lender carries out a foreclosure sale, the second mortgage lender may also bid for the property at the time of foreclosure sale. Even after the property has been sold at auction, the second mortgage lender may pay off the required amount of money to the first mortgage holder and get the property back at the end of the “redemption” period. These last two options are attempts to recover the money the second mortgage holder has invested, although they are rarely undertaken (particularly in a weak housing market).

Collecting on an Unpaid Debt

A second mortgage lender can also charge-off any unpaid debt after getting a part of the sale proceeds when the first loan is paid off. This means the second lender considers the debt uncollectible, but legally the borrower still owes the money. Therefore, if the second mortgage holder charges-off the loan, while it will no longer pursue a borrower, the second mortgage holder can still sell the right to collect on the debt to a third-party collector. The third-party collector has the legal right to make continued attempts to collect the debt. The charge-off will negatively impact the borrower’s credit score. In addition, the charge-off may be considered income by the IRS. However, federal law does provide for relief, depending on the circumstances.

Case Studies: What Happens to a Second Mortgage in a Home Foreclosure?

Case Study 1: The Smith Family – Insufficient Funds to Pay First & Second Mortgage Lenders

The Smith family is facing financial difficulties and has taken out both a first and a second mortgage on their home. However, they are unable to keep up with the mortgage payments, leading the first mortgage lender to initiate foreclosure proceedings.

The property is eventually sold at a foreclosure auction, but unfortunately, the sale proceeds are not sufficient to cover the outstanding balances on both the first and second mortgages. As a result, both lenders have the right to sue the Smith family for the remaining balances, including interest and other costs.

If successful, the lenders can take legal actions such as garnishing the family’s wages, seizing their bank accounts, or placing a levy on other non-exempt property, as permitted by state laws.

Case Study 2: The Johnsons – Second Mortgage Holder Buys Back the Property

The Johnson family also faces financial hardship, and their home goes into foreclosure due to defaulting on their first mortgage. During the foreclosure sale, the second mortgage lender, recognizing the potential loss on their investment, decides to bid for the property.

The second mortgage lender is willing to pay off the required amount to the first mortgage holder and successfully acquires the property during the “redemption” period. By doing so, the second mortgage holder aims to recover the money they have invested, although this is an uncommon occurrence, particularly in a weak housing market.

Case Study 3: The Thompsons – Collecting on an Unpaid Debt

The Thompson family has a second mortgage on their home. However, due to financial hardships, they are unable to make the required payments, resulting in the first mortgage lender initiating foreclosure proceedings. Once the property is sold at auction and the first mortgage is paid off, the second mortgage lender faces an unpaid debt.

They choose to charge off the debt, considering it uncollectible. However, legally, the Thompsons still owe the money. The second mortgage lender then decides to sell the right to collect the debt to a third-party collector. The third-party collector can now legally pursue the Thompson family for repayment of the debt, employing various collection methods.

It’s important to note that the charge-off will negatively impact the Thompsons’ credit score, and the charged-off amount may be considered income by the IRS. However, relief options may be available under specific circumstances.