February 2008 Archives

February 11, 2008

How To Reduce Your Mortgage Payments While Avoiding Foreclosure

istock_000004045047xsmall.jpg If you're like many homeowners, your home is encumbered with a second or third mortgage (or deed of trust), and perhaps a home equity loan. Numerous articles describe you as using your home like an ATM machine. Having all these secured debts on your home is tantamount to a juggler having too many balls in the air -- at least one must fall, sooner rather than later. If, for one reason or another, you just can't keep up, you may be able to avoid foreclosure if you pay the right loan and either blow off the rest, or at least make reduced payments. In almost every case, the right loan to stay current on will be your first mortgage or deed of trust. While I'm always hesitant to tell people to stop meeting their shelter obligations in full and on time, sometimes it's the only rational thing to do -- as wrong as it may feel to many of you. If reducing the amount you throw at your home every month will let you stay there and keep your ahead above water, at least until you can work out a better solution, I'm all for it. How does this work? When you originally took out the loan to buy your home, you agreed to have the loan (or loans) secured by a mortgage or deed of trust (depending on the state where the property is located). (For the rest of this blog, I will use the term "mortgage" to refer to both mortgages and deeds of trust.) By recording the mortgage in your local land records office, the lender created a lien (legal claim) on the property, which can be enforced by foreclosure if the payment terms of the mortgage document aren't met. As you probably know, in foreclosure the property is sold to make good on the promissory note underlying the mortgage. The main loan you used to buy your home is termed a "first mortgage." Why first? It's almost always recorded first and gets paid first in case of a sale. In the same manner, a second loan secured by the home is a second mortgage. For example, it's common to use a first mortgage to pay 80% of the sale price and get a second mortgage for the additional 20%. And that's not all. In the bubble years, home value appreciation supported additional loans against the home, often in the form of a home equity lines of credit. As with the first mortgage, the lender's primary remedy for a default on these additional loans is foreclosure. For foreclosure to be an effective enforcement remedy there has to be enough equity in the home to pay off the holder of the loan being foreclosed. And if the home is sold in foreclosure, all senior lien holders (in that a first mortage is senior to a second mortgage) have to be paid off first. For that reason, until the last several years, banks wouldn't lend in the absence of good credit and a healthy chunk of equity to secure the loan. In the bubble years, however, many loans were made on the expectation that values would rise fast enough to provide adequate security for the prospective loan, even if there was no measurable equity at the time. Also, liberal (dare I say "dishonest" or "fraudulent"?) appraisals were easy to come by. It's easy to see what happened when the crash came. Not only did homes stop appreciating in value, but the values continue to plummet, erasing whatever equity there may have been at the time of the loan as well as erasing the hope of equity to come. Importantly, then, if in your case one or more of the loans on your home has become unsecured-in-fact -- or never was secured to begin with -- skipping payments won't result in a foreclosure action. Sure you may get sued, but the lender's only remedy is to get a money judgment and put another lien on your home, just in case some equity develops in the future. And lawsuits usually take a long time to develop, giving you the opportunity to raise some money from another source and make up the payments or settle with the lender for less than you owe. Remember, the only reasoning for this strategy is the assumption that you can't afford to remain current on your "mortgage debt." To determine whether the loans on your home are secured or unsecured (as a factual matter), begin with your home's value (be optimistic, but sensible) and subtract the first mortgage. If you hit zero or below, foreclosure is not a viable remedy for the other lenders, since there is no equity left in the home to pay them off. Assume, for example, that your home is worth $400,000. You have a first mortage of $350,000, a second mortgage of $50,000 and home equity line of credit worth $25,000. When you subtract the first and second mortgages from the home's value, you get zero. If you stop making payments on the home equity loan, the lender won't benefit from a foreclosure, since there wouldn't be anything left from the sale after the first and second mortgage holders are paid. Of course, it's not always that simple. Sometimes a second or third mortgage is partly secured and partly unsecured. In that case, a foreclosure by the junior lien holder might recover some of the lien but not all of it. On the other hand, when foreclosure does occur, in most states it wipes out all the junior liens, regardless of the equity in the home. For instance, in the earlier example, if the owner of the first mortgage foreclosed on the loan, the liens held by the holders of the second mortgage and the home equity line of credit would both be extinguished, even though there was still equity (at least theoretically, since foreclosure sales usually accept bids far lower than the perceived market value).

For more information on avoiding foreclosure, see The Foreclosure Survival Guide, by Stephen Elias (Nolo), an essential tool for anyone at risk of foreclosure.

February 1, 2008

When Are Collectors Prohibited from Suing for Unpaid Debts?

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If you have old, unpaid debts, you may be safe from a lawsuit to collect the debt, because a creditor or debt collector has a limited number of years to sue you for the debt. To get a better understanding of time limits for debt collection, check out this newly published article in the Nolopedia, "Time-Barred Debts: When Collectors Cannot Sue You For Unpaid Debts".

And if you want further information on debt collection & credit, you might also be interested in my previous post, "When Credit Bureaus Report Debts Discharged in Bankruptcy: It Should Be a Crime".