Lenders holding second mortgages will, assuming the first mortgage is in default, face decisions as to how to best protect their interests in the property. These questions typically come to the forefront when the first mortgage holder files a foreclosure suit and names the second mortgage holder as a defendant. The bank in second position has a right to pay off (or “redeem”) the first mortgage and, in Florida, this right will continue until the later of (1) the date the foreclosing bank specifies in its foreclosure judgment or (2) the date the clerk enters a certificate of sale. The second mortgage holder could also make an offer to the first mortgage holder to buy its note and mortgage, typically for some discounted sum. However, in that event, junior bank would have to continue the first mortgage foreclosure case to completion and would need to deal with any defenses raised in that case.
Another option for the second mortgage holder is to wait until the first mortgage holder completes its foreclosure and then bid on the property at public sale. For an excellent summary of Florida’s foreclosure bid procedure, readers should refer to a recent post by Scott J. Kennelly entitled Florida Foreclosure Sales: Developing a Maximum Bid. While a first mortgagee will obtain a judgment and resulting bid credit to use at foreclosure sale, a second mortgage holder named as a defendant in a first mortgage foreclosure will not have that “bid credit”. As a result, the amount it bids would need to be paid in cash. To the extent that the winning bid is higher than the first mortgage balance, the junior bank would be in position as second lienholder to apply to the court to disburse the surplus to it following the sale.
Consider the following example of this process: Assume a $200,000 first mortgage and assume a $100,000 second mortgage. Further, assume the property value would yield a net of $350,000. In the first mortgage foreclosure, the bank would have a $200,000 bid credit and, due to equity in the property, will likely bid that amount. The second mortgage holder’s maximum bid in that case could be, say $250,000 (which when added to the $100,000 original loan amount gives a total amount “loaned” of $350,000). In that case, if the second mortgage holder is the high bidder, it would receive title to the property. Since its bid exceeded that of the first mortgage holder by $50,000, it would apply to the court for the surplus. The second mortgage holder’s net “investment” would be $300,000 ($100k loan plus $250,000 bid less $50,000 surplus proceeds) allowing it to capture $50,000 recovery from the equity in the property and be left with a $50,000 loss on the loan.
If it were outbid by a third party, the second mortgage holder’s recovery would be greater. Assume, for example, that a third party bids $275,000, thus outbidding both the second lienholder and the first mortgage holder. There would be a surplus of $75,000 for which the second mortgage holder would apply, resulting in a net loan loss of only $25,000. In this case, it would obtain this recovery without the risks of taking title and having to resell the property.
Of course this is a simplified example and there are many factors to consider in determining the property value, including the anticipated holding costs, taxes, assessments and the like. In any event though, these options do not require the foreclosure of the second mortgage as they can be exercised by the junior lienholder in its capacity as a defendant in the first mortgage foreclosure. This “wait and see” strategy can be effective providing the first lienholder is moving its foreclosure case along.