Despite heavy political pressure to write off so-called "junior"- or second-lien, mortgages to help struggling owners keep their homes, banks aren't always willing to follow that script. Why? Because those loans amounted to $1 trillion in the U.S. at the end of last year, according to the Federal Reserve, and many banks hold a lot of that paper. A second trust deed is a loan in a subordinate position to a first trust deed loan secured by the same collateral.
Although owners and many banks are trying to strike deals to reduce the payments on homeowners' first mortgages, the main sticking point to consummating those transactions is that lenders holding the first liens often will not accept a deal unless the banks holding the second mortgages take a hit too. But those banks, which are trying to get their assets back in the positive column, don't always want to write off the junior liens.
It's not unusual for second liens -- typically loans taken out after the house was purchased -- to lack collateral backing today because of the steep drop in home values; sometimes a second mortgage is below the amount owed on the first mortgage alone. That's why some politicians are urging banks to write off those "worthless" second liens. Many homeowners who are in default on their first mortgages, however, still are making monthly payments on the second liens, so banks don't want to kiss those loans off. The ability for banks to collect on second liens varies by state.
How pervasive is the problem?
"I see it all the time," says accountant Earl Salter, an enrolled agent with Norwalk Business Service in Norwalk, Calif. Financially shaky owners who have lost their homes to foreclosure and face second-lien lenders demanding repayment "have two choices: file bankruptcy or try to strike a deal with the holder of the second to accept 10 or 15 cents on the dollar" owed, he said.
If lenders and borrowers don't strike a deal, lenders may garnish the borrowers' wages and other assets, if the owners have some income or the potential for income. In some cases, banks sell the junior-lien loans to collection agencies, which take over recovery of the debt.
While many banks are making decisions about repayment of second-lien loans on a case-by-case basis, lawmakers are seeking solutions for borrowers unable to repay junior-lien debts. One U.S. Treasury program requires the reduction of payments on junior-lien mortgages by participating lenders if they're allowing reductions on first mortgages.
Of one thing you can be sure: we haven't heard the last of this issue yet. Other programs already are on the table.