As Spring came this year, the news was filled with reports that we would see an especially large crop of ciccadas this year as the 13 year brood is coming at the same time as their 17 year cousins. But it isn’t just insects emerging this year as we learn of the mortgage industry’s version of the 17 year insect. The danger of these critters is the bite they can take out of your home equity.
If we role the clock back to 2007 Americans were furiously buying homes and fulfilling other needs using second mortgages to invest or get what they thought they needed. Second mortgages were being deployed to finance home improvements and second home purchases as well as debt financing and other stuff. Stocks were in a three year bull market. People loved the concept because back then mortgages were in the 5-6% range, at that time a 30 year low. And, recall this, second mortgage interest was largely deductible.
Result: Americans took on a huge amount of mortgage debt; both primary and secondary. Then in December 2007 the sub-prime mortgage market began to wobble. Three months later Bear Stearns collapsed. By September the Treasury had to take over lenders Freddie Mac and his sister Fannie Mae with Lehman Brothers folding the following week. The housing market collapsed, especially in resort markets like Florida. People across the country were living in $300,000 homes that now had $450,000 of mortgage debt.
When you take a mortgage you sign a promissory note to pay the amount loaned over time and you pledge your house as security for that loan. The lender stuck the note in its file cabinet and recorded the mortgage at your nearby courthouse so that anyone could see what debt you owed. There were lots of defaults in 2009 as people lost jobs or the income needed to pay both mortgages. The second mortgage lenders did not aggressively chase the debt because if they foreclosed on the house, the resulting sale would barely pay the primary mortgage lender. As the economy slowly dug out of the 2009 recession, many borrowers claim the “forgot” they had these loans. Usually, lenders who are defaulted upon make a lot of noise but 2009-2010 was a tsunami of default such that big lenders couldn’t keep pace with demands for payment. Things got very quiet and borrowers certainly weren’t hustling to resume payments for debt on a home that exceeded its value.
Meanwhile, smart money private equity investors were buying up these second mortgages for cents on the dollar. The debt they bought was in default, but default debt comes pregnant with all kinds of interest and penalty clauses…much like what credit card lenders do when you miss a payment. For a long time, these “investors” stayed underground while the economy and home prices stabilized. Then came Covid and suddenly home prices shot through the roof. The $300,000 home of 2011 was now a $525,000 home and the first mortgage had been paid down from $250,000 to $200,000. Thus, 2011’s negative home equity became today’s $300,000 in positive home equity. So, in a divorce setting, wife is getting the house and with it that $300,000 equity in equitable distribution. One day wife goes to the mailbox and there is a letter from Speedwagon Private Equity. They acquired the second mortgage husband and wife gave Countrywide mortgage company back in 2011 and since no payments have been made on the 2007 Countrywide second mortgage, the balance due on that loan is now double what it was when the loan was taken, call it $100,000. Please remit your check to Speedwagon for $100,000 in the next thirty days or they will begin foreclosure proceedings on the second mortgage.
Hold it. Wait. Wasn’t that debt forgiven? What’s a Speedwagon and how did a $50,000 loan become $100,000 without me or the ex spouse knowing about it? These are perfectly normal client questions. Unfortunately, the answers are not going to make them happy. You signed a note. It had all kinds of nasty interest and penalties if you did not pay. You didn’t pay. You didn’t get anything that said your obligation was discharged or the mortgage was cancelled. If you had seen the obligation discharged, you would have been taxed on that income. So, these Speedwagon people have been lying in wait for you; waiting to see if your home value would rise high enough that they could come after you for what you borrowed plus all their crazy interest and penalties. And you may have settled your divorce with your spouse assuming the debt had disappeared. Now the letter says the note is due and if not paid, foreclosure will begin to sell your house and pay the forgotten debt.
Implausible? No. National Public Radio is reporting that these letters are being sent and that foreclosure proceedings are coming soon after because not many folks have a spare $100,000 to satisfy the debt. They indicate that some of the interest and penalties may violate consumer protection laws and that can slow down the litigation or induce some compromise on the amount claimed. But if you borrowed the money, you have the burden of showing why you didn’t have to repay it.
This presents a divorce issue as well. Most lawyers figure that people know what mortgages they have signed. But this is a new phenomenon. Ignore just about any other debt and your mailbox and answering machine fills with demands for payment. But these second mortgages are like cicadas. They are emerging from the ground after a long hibernation and their bite is substantial. It may be provident for lawyers and clients to check title records to search for recorded mortgages, long since forgotten.
The NPR article is here: https://www.npr.org/2024/05/10/1197959049/zombie-second-mortgages-homeowners-foreclosure
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