Does Property Value Decline Eliminate a Second Mortgage Lien?

July 16, 2010, Revised July 26, 2010, Reviewed September 11, 2013

“I received a confidential note from a firm claiming that they can eliminate my second mortgage. I am inclined to believe them because the value of our home is now less than the amount of the first mortgage. Is this an opportunity or a scam?”

 The Process of Removing a Second Mortgage Lien

The answer to your question is not clear, but the misinformation in the note they sent you suggests a need for caution. The note says “that your 2nd mortgage …may be eliminated due to a significant decrease in property values in your area…” In fact, the decline in the value of your home does not in any way eliminate the second lien on your property, or your legal obligation to pay the second mortgage.

The only way to eliminate the obligation is to negotiate a deal with the second mortgage lender to remove it. When a borrower has negative equity, a second mortgage lender may be willing to relinquish its claim for a fraction of the amount owed because the alternative may be to lose it all.

 Bargaining Position of the Second Mortgage Lender

Some borrowers with negative equity remain current on the first mortgage but stop paying the second. 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 allows the borrower a free ride and might encourage other borrowers who are under water to do the same.

Second mortgage lenders who would like to extricate themselves from situations like these may be receptive to a proposal that would leave them with something rather than nothing. This might be a cash payment, an unsecured note for some or all of the loan balance, a share in future house appreciation, or some combination of these.

The second mortgage lender in this situation has one bargaining chip. The borrower won’t ever be able to sell the house without paying off the second mortgage, and the payoff amount will include all accrued interest and penalties. It would be foolish for the borrower to ignore this.  

 Retaining a Third Party

The company that contacted you wants you to authorize them to negotiate with the second mortgage lender on your behalf. While they can’t do anything for you that you can’t do for yourself, a professional who has done it before might be worth the cost. Before I took that plunge, however, I would do my homework on the firm, which would include interviewing past clients.

Second Mortgages in Bankruptcy

My first version of this article neglected the possibility of bankruptcy, an oversight that was brought to my attention by Richard Feinsilver, who practices law in New York, and by L. Ilaine Upton from Virginia. They indicate that if there is no equity behind a second mortgage, the lien can be eliminated by court order in a Chapter 13 bankruptcy. This does not eliminate the debt, but most Chapter 13 plans require only partial payment of unsecured debt. 

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