Second Mortgages Vex Borrowers
By James R. Hagerty
The Wall Street Journal
April 12, 2010
After losing her condo in San Diego to foreclosure last year, Charissa Kolich thought that at least she was free of mortgage bills.
But Wells Fargo & Co., which holds a home-equity loan made five years ago to Ms. Kolich, last month filed a lawsuit against her in the Superior Court of California, San Diego County, seeking to collect the nearly $72,000 it said she still owed on that second mortgage. "This was all kind of a shock," says Ms. Kolich, a food-service administrator recently diagnosed with inoperable brain cancer.
Banks are coming under increasing political pressure to write off or at least write down second-lien and other junior mortgages as a way to help borrowers keep their homes or extract themselves from heavy debt. As the Wells Fargo suit shows, however, banks often are reluctant to give up on loans when they see a chance of recovering all or part of their money.
This issue will be the focus of a hearing Tuesday by the House Financial Services Committee in Washington. Panel members are due to quiz executives from Wells Fargo, Bank of America Corp., Citigroup Inc. and J.P. Morgan Chase & Co. about their junior-lien mortgage policies.
Why do junior-lien mortgages matter? The $1 trillion of junior-lien mortgages outstanding in the U.S. at the end of 2009 added up to only about 10% of total home-mortgage debt, according to Federal Reserve data. But many banks have large holdings of these junior liens. Among borrowers whose first mortgages were packaged into so-called private-label securities (those not backed by any government entity), about half also have junior-lien loans, according to mortgage-bond trader Amherst Securities.
Those junior liens now represent one of the trickiest obstacles to efforts to get distressed borrowers back on their feet. Borrowers who negotiated lower payments on their first mortgages often find they are overwhelmed by payments on second mortgages and other debts.
The owners of first-lien mortgages (mostly investors in mortgage securities) are reluctant to reduce payments or cut principal for troubled borrowers unless holders of the junior liens (mostly banks) also take a hit. But banks, struggling to rebuild their capital, don't want to write off any more junior liens than they must.
Many junior liens lack collateral backing because home values have fallen below the amount owed on just the first mortgage. "Large numbers of these second liens have no real economic value," Barney Frank, a Massachusetts Democrat who is chairman of the House Financial Services Committee, said in a recent letter to the big banks. He added: "I urge you in the strongest possible terms to take immediate steps to write down these second mortgages."
But many people who have fallen behind on their first mortgages are still making payments on their junior liens, and banks say they shouldn't have to write down loans that are performing.
Even in cases where a foreclosure or related action has turned a junior-lien mortgage into an unsecured loan, lenders may still be able to collect, though state laws vary on this point. Leo Stawiarski Jr., a lawyer in Englewood, Colo., who advises banks, says they should assess each borrower's ability to repay any second mortgage after a foreclosure. For borrowers who have sufficient income or other assets, or are likely to have the means in the future, banks should try to negotiate a settlement involving at least partial repayment, he says. If borrowers refuse to cooperate, lenders in some cases can garnish their wages or other assets.
Mr. Stawiarski believes banks should, and eventually will, become more aggressive in pursuing these claims. "I think lenders are really leaving a lot of money on the table," he says. One option for banks is to sell junior-lien loans to collections firms, which can then pursue borrowers.
Representatives of J.P. Morgan Chase and Citigroup declined to comment on their junior-lien collection policies. A spokeswoman for Bank of America said that if efforts to avoid a foreclosure failed, "then we do reserve the right to recover the unpaid balance on the second lien if permissible by state law. However, our practice has been to only to pursue recovery in situations where we believe the customer has sufficient nonretirement assets to satisfy their debt obligation."
In response to questions about the suit Wells Fargo filed against Ms. Kolich, a Wells spokeswoman said: "We consider customer hardships on a case-by-case basis and we would welcome a call from the customer to discuss settlement options." Alleda Harrison, a lawyer for Ms. Kolich, said Wells ignored past requests for talks on a settlement. The original purchase of Ms. Kolich's condo was financed by a first and second mortgage in 2004, Ms. Harrison said, and Ms. Kolich refinanced that second mortgage in 2005 to lower the rate but didn't take any cash out.
Meanwhile, the Obama administration is prodding banks to find solutions for more borrowers struggling with junior-lien debts. Under the administration's foreclosure-prevention program, one new U.S. Treasury program requires participating lenders to reduce payments on junior-lien mortgages if they are doing so on first mortgages.
The government also is offering incentive payments for second-lien holders to forgive debts for borrowers who avert foreclosure by selling their homes for less than the debt owed or turning the deed over to the lender. Under that program, the holder of the second lien can be paid, partly by the government, as much as 6% of the outstanding loan balance, up to a maximum of $6,000, but in return must renounce efforts to collect anything more from the borrower.
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