Short Sales Stopped By Second Mortgages

A report by RealtyTrac highlights a problem for borrowers interested in a short sale of their home. According to Bloomberg, a RealtyTrac analysis showed only 4.2 percent of short sales were completed in the first quarter with second mortgages.

The Bloomberg story notes that some holders of second mortgages can be demanding during negotiations, and stop a short sale cold.

While a second mortgage holder may have the power to cause problems for a short sale, their power is not unlimited.

If the home mortgage is underwater, the second lien holder is in the unenviable position of having gone from being a secured creditor to being unsecured. The second mortgage is now the equivalent of credit card debt, because there is no equity in the home to secure it.

Relief Through Chapter 13 Bankruptcy

Borrowers who are underwater and have a second mortgage could file a Chapter 13 and have the bankruptcy court strip the lien in the bankruptcy.

In a Chapter 13, borrowers can reorganize their debts, pay mortgage arrears and remove any second mortgages on an underwater loan. This may give them the flexibility to remain in their home.

During the Chapter 13, if they are unable to maintain their plan payments or it no longer makes economic sense to stay in the home, they could convert to a Chapter 7 and discharge most of their remaining debt, including any deficiency balance caused by a short sale or foreclosure.

A bankruptcy attorney can provide advice as to whether a Chapter 7 or Chapter 13 bankruptcy would be the best solution for borrowers dealing with an underwater mortgage.

Source: Bloomberg BusinessWeek, “Home Sales Held Hostage by Junior Lien Holders: Mortgages,” Prashant Gopal and John Gittelsohn, July 23, 2012.

For more information on this topic, please see our Florida short sale page.

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