Get a Break on Your Second Mortgage

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"Underwater" homeowners can’t get mortgage lenders to cut them a break—or so it seems.

Despite the red tape, they often have a better shot at renegotiating terms on a second mortgage, says Jack M. Guttentag, emeritus professor of finance at the University of Pennsylvania’s Wharton School.

Guttentag admits homeowners often receive deceptive solicitations suggesting that eliminating a second mortgage is easier than it is. But homeowners do have more leverage with the lender on their second loan than their primary one. That’s because the second lender’s rights are subordinate to the first, so the second lender may be more willing to accept a partial payment.

“When a borrower has negative equity, the second mortgage lender may relinquish its claim for a fraction of the amount owed because the alternative may be to lose it all,” Guttentag says.

Experts estimate nearly one in four homeowners — approximately 11 million — owe a mortgage worth more than their home due to the price collapse over the past few years. While some borrowers would rather walk away, others are trying to renegotiate terms on their own or through government programs. Many cut their interest rates, along with the size of their monthly payments.

Homeowners do have a hard time convincing lenders to reduce the principal, or outstanding debt. In some cases, lender and borrower are in a game of chicken, with the lender betting the borrower won’t follow through on a threat to walk away. Other times the lender stalls, hoping economic conditions will improve. A lender in a primary mortgage typically loses money in a foreclosure, and because there are many legal and other expenses, the underwater property will sell for less than the lender is owed. Still, the primary lender may well get 50% or more of what it is owed. The secondary lender, however, gets nothing in a foreclosure until the primary lender gets 100% of what it is due. So the second lender in an underwater situation is more likely to lose it all.

“Some borrowers with negative equity remain current on the first mortgage but stop paying the second,” Guttentag says. “This puts the second mortgage lender between a rock and a hard place. If the second mortgage lender forecloses, it will get nothing, but if it doesn’t foreclose, it grants the borrower a free ride and might encourage other borrowers underwater to do the same.”

Guttentag urges homeowners to try various approaches in dealing with a second lender. They can ask the lender to accept their cash and settle the debt for less than the original cost. Or the lender can replace the loan with an unsecured note for all or part of the debt. With the property no longer serving as collateral, it is often easier for the homeowner to sell.

In a third arrangement, the lender can retire the old loan in exchange for the right to share in any future appreciation of the property’s value.

To renegotiate the terms of your loan, contact the firm receiving your second-mortgage payments. Some homeowners can try to negotiate themselves. Others can seek out professionals. Just be sure to research every firm knowing exactly what services it will provide at exactly what cost. And be wary of any firm demanding a large up-front fee. The Federal Trade Commission offers a wealth of tips for avoiding mortgage and foreclosure scams.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

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