Like a sleeping bear, long-silent second mortgages hibernate in people’s houses these days. They are quiet, a snoozing predator, just waiting for spring.
And it can be bloody when those sleeping mortgages awaken hungry and look around for something to fill its pocket.
Here in California the coming slaughter is particularly noticeable because the value of real estate has rebounded in many areas of the state.
Waves of foreclosures have now started lapping on the financial beach just as the federal government declares that everything is coming up roses for the economy.
These foreclosures are kin to the FIRST WAVE that devastated the nation. Both were triggered the largest financial fraud in US history. (A massive systemic fraud the US taxpayer was obliged to finance while being victimized.)
The current wave of foreclosures involves the “Sleeping Giant Second Mortgages” on millions of homes across the country.
“I Thought It Went Away”
For more than half a decade, the gigantic financial fraud carried out by Wall Street and the lending industry jack-hammered real estate prices to such low levels that second mortgages had no chance of receiving a penny if they foreclosed.
Worse still, if they foreclosed, they would be saddled with paying a first mortgage that was no longer fully secured by the value of the real estate. In the icy financial winter that followed, many second mortgages holders took the “long nap”.
Second lenders stopped calling the homeowner. They stopped sending the homeowner ANY notices relative to their second mortgage(s). They hibernated.
Here in California many second mortgage holders went even further.
They told homeowners typically over the phone that the lender had “charged the loan off their books”. Then the lenders coupled this a form 1099-C. (Sometimes a 1099-A, or my personal favorite, the form 1099-MISC which is an absolute outrage. We’ll talk about form 1099(s) issues by the lending industry in another article soon.)
What was a homeowner to think? “They didn’t call”…”They didn’t write”…”They charged it off”…”They sent out a form 1099 for debt cancellation.”
Homeowners by the millions concluded “It went away.” But it didn’t.
A Second Mortgage isn’t a Puppy that Follows You Home
You aren’t getting a “free” loan that you don’t have to repay because the lender needs to show you the note or because MERS is illegal.
Don’t waste your time on this nonsense.
In California the horrible truth is that EVEN the issuance of a form 1099 for debt relief in the situation described above, DOES NOT, in and of itself, mean the debt has been cancelled within the meaning of Section 108 of the Internal Revenue Code.
It can simply mean a particular lender has written the debt of their books. In all probability it means the debt was sold to someone else to collect. (They virtually always end up in the hands of another creditor.)
If there is a recorded deed of trust or mortgage instrument, and there virtually always is, the loan is a secured loan.
A loan secured by real estate is just about the best form of long term debt anyone can hold DEPENDING ON THE VALUE OF THE REAL ESTATE.
So when the value of real estate began to go up decisively, these secured second mortgages begin to “bloom” like California Poppies in spring.
When the Second Mortgage Wakes Up, You Need To
When a second mortgage holder comes out of hibernation, they are typically ravenous.
Like a grizzly bear with an empty stomach, they will initiate foreclosure and eat your home with little ado. It is a very good bet the lender is well versed as to the current value of the real estate and will feel quite confident that they can obtain the yield necessary to make the process worth their while.
Actually it’s much better if you “wake up” before the second mortgage holder does. You almost always have better options if you face this problem as early as you can.
There are still rare cases in which the value of the property currently is less than the first mortgage. If so, a Chapter 13 bankruptcy can be used to strip off the second and discharge it for virtually pennies-on-the-dollar while the homeowner retains the house.
If the house still has a very depressed value the homeowners may be able to negotiate a reduced settlement figure and permanently cancel the debt. (In which case a form 1099 should be expected for the tax year in which the note is cancelled in exchange for the reduced payoff.)
There may be other moves a homeowner can make, like using a bankruptcy to catch up all the missed payments on a sleeping second. I hate this one but in the case of folks who can afford the payments, and who want to keep the home, this may be viable.
Sometimes it’s time to sell the house. I like my homeowners to sell their homes at premium prices long before some “snarling second” files a Notice of Default (N.O.D.) artificially depressing the value of the real estate.
Avoid a Notice of Default if You Can
If at all possible, don’t let a second mortgage holder get to the point where they have filed a Notice of Default before you take action.
You are then on the defensive and your options dwindle with each passing day. Worse yet, lenders will deliberately engage you in fruitless dialogue to try to draw out the time until they can sell your property.
I’ve seen this type of violation of the duty of good faith and fair dealing by lenders over and over again. Almost none of the dialogue will be in writing and it’s hard to prove in court.
Especially don’t wait until a date has been set to sell your property.
In California the non-judicial foreclosure train has left the station once an N.O.D has been filed. There are only three general methods to “stop or slow” this train.
Each method has its benefits and burdens. Often one or more of the methods are practically impossible for the homeowner to utilize.
You need to start early. There are no EASY ANSWERS.
But there are more options and better answers the sooner you shake off your winter slumber and sneak up on the sleeping giant in its lair.
Guest author Bill Purdy is a tax and real estate lawyer with Simmons and Purdy in Soquel, California. He and his partner Pam Simmons are my go-to resource for all matters of tax and mortgage law. I’m tickled to share Bill’s pointed perspective on California mortgage law.