During the housing boom, mortgage lenders came up with new and exotic mortgages to put people in homes.
One of the most common mortgages was an 80/20 mortgage. You would be given a first mortgage which would cover 80 percent of the cost of the home and then a second mortgage that would cover the remaining 20 percent of the loan. The 80% mortgage would be in put in first position and the 20% mortgage would be put in second position. You had this second mortgage to avoid paying PMI payments each month.
You would put no money down, so essentially you went from renting to paying a mortgage without any pain in the pocket, in fact, a lot of these mortgage payments were less than what a person could rent for.
Very few thought about the chances of these homes going down in value (I did, but I make Murphy look like an optimist). The idea was that the house would increase in value in a few years and there was no risk in there being a lack of equity in the home because real estate always went up.
There were a few who did think about the chance of property losing value and a few of them were mortgage lenders. Some of these lenders made the 20% mortgage the mortgage in first position and this is why:
A secondary mortgage can be considered completely unsecured if the value of the property is less than that of the first mortgage. For example, suppose a borrower has a first mortgage balance of $200,000 and a second mortgage balance of $40,000. Now in our example, the house is worth $180,000. The house is worth less than the balance of the first mortgage and that makes the second mortgage completely unsecured.
There is an option inside a Chapter 13 ba
nkruptcy to have that second mortgage treated as unsecured. In the Eastern District of Pennsylvania, where I practice, you need to have a motion to value the real property and then file an adversarial matter to have the mortgage treated as completely unsecured.
The only way to have the mortgage treated this way is if it were COMPLETELY unsecured. That means if the property is worth $200,000.01, the second mortgage is not completely unsecured and you cannot treat any of it as unsecured.
What a few unscrupulous lenders did during the housing boom was to put the 20% mortgage in first position. Now when the borrower finds themselves in financial straits and files Chapter 13 bankruptcy, the option to claim the second mortgage is completely unsecured is off the table because the documents were filed incorrectly, deliberately or not. The 20% mortgage is considered the first mortgage and unless your property has really taken a dive in value, the 80% mortgage is not going to be completely unsecured.
This is an area that is ripe for another class-action lawsuit, even if you are not planning to file Chapter 13 bankruptcy, because bank malfeasance has taken this option off the table. If you find yourself struggling to keep up with your debts, please call 610-928-1233 or email me at jim@padebt911.com for a free consultation or a referral to an attorney in your area.