One of the consequences of the real estate bubble of the early 2000s is that most people are now faced with not only one, but two mortgages secured by their home – and more often than not the home’s value is actually less than the mortgages on it.  Yesterday’s blog post discussed how your home is affected when you file for bankruptcy, but it discussed mostly information relevant to your first mortgage. 

The “rules” for your second mortgage are essentially the same, but have a little reality twist to them.  Let’s start with how it works in a Chapter 7 bankruptcy:  Technically, in order to keep your house through the bankruptcy, you must be current on the date of filing your petition.  Otherwise the bank will file a Motion for Relief of Stay, which essentially asks the court for permission to sell your house at auction.  However, if the value of your home is less than what you owe on your first mortgage, or only a little bit more, the second mortgage really has no incentive to do this.  You see,  the sales proceeds from the sale are paid to the creditors in order of priority.  Therefore, if you owe 200K to the first, and 100K to the second, but the house only sells for 150K at auction – the second gets nothing – and if the second bank is the one initiating the sale, not only do they get nothing, they also incur all the expenses associated with the sale.   This reality-based twist means that while the law gives the bank the right to foreclose if you are not current on your second mortgage when you file your Chapter 7 bankruptcy, they generally don’t.

 The only time the bank may have incentive to proceed anyway, is if the first and second mortgage are through the same bank.  If that is the case, you must be current on your second mortgage as well as your first mortgage in order to make sure that you can keep the house.

The next question then turns to what happens to the second mortgage in the bankruptcy, especially if you are not current with payments.   You have to look at your mortgage as a two-part deal.  Whenever you have a mortgage, and you default, the bank has the right to (1) proceed against the house, by selling it at auction; and/or (2) proceeding against you personally, by suing you in civil court.

Your Chapter 7 discharge will protect you from a future law suit by the mortgage company because as long as you do not reaffirm the debt (which is not a requirement in order to keep real property – don’t let your bank tell you otherwise) your PERSONAL liability on the loan is discharged.  However, the bank still has a security interest in your property, meaning they can still use option (1) and proceed against your house.  This is why you need to make sure that you deal with the second mortgage eventually (settlement, modification, catch it up) – otherwise there is a chance that when your house has increased in value, the bank holding the second mortgage forecloses….and after having paid on your first mortgage for so long, that would truly be unfortunate. 

There are some other alternatives available to you in a Chapter 13 setting – more on that tomorrow, so stay tuned, or if you cannot wait and wish to speak to me about your options – please call 480-275-4894 to set up a free consultation.