Do I or Don’t I? The Real Truth Behind 2nd Mortgage Charge-Offs

Financial hardship has struck and you found yourself unable to pay your 2nd mortgage.  The bank sent you a notice that it charged off the lien, so now you’re wondering if that means you still have to pay.

Let’s explore what 2nd mortgage charge-offs are and the effect a charge-off has on your home both within and outside of bankruptcy.

The Meaning of Charge-offs

My clients in Dallas often ask about the meaning of a charge-off. In its simplest form, a charge-off DOES NOT equal debt forgiveness. 2nd mortgage charge-offs mean the creditor is no longer treating the loan as active. The creditor does not want to include the loan balance in its accounts receivables any longer for accounting principles (tax saving schemes).

This does not mean that you do not owe the debt; a charged off loan can still be sold to a collection company and that company is free collect upon the debt in any manner allowed by law.

2nd Mortgage Charge-Offs Outside of Bankruptcy

Furthermore, if it is a 2nd mortgage charge-off, the lien is still attached to the property. This means that if the home is sold, at closing, the title company will demand that the mortgage be paid in full before a deed is issued to the buyer.

In reality, what this means for your daily life is that you may not be required to make monthly payments to any creditor on the charged off 2nd mortgage but you still owe the debt, and if you were to sell your house the debt would have to be paid in full out of the proceeds of the sale before you received any money.

2nd Mortgage Charge-Offs in Bankruptcy

The Supreme Court addressed the issue of 2nd mortgage charge-offs in the case Nobelman v. American Savings Bank 508 U.S. 324 (1993). In the opinion, Justice Thomas discussed how two provisions in the bankruptcy code work together to answer the question of whether or not a mortgage lender’s rights can be modified.

Chapter 13 allows Debtors to reorganize mortgage arrears (missed payments) and pay the missed payments back over a five year period in a more affordable payment plan.  Section 1322(b)(2) operates to state that a Debtor’s plan may:

“[m]odify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims.”

Side note – this is where lawyers get super nerdy. The entire opinion from the Supreme Court, which is to say the making of the law because you can’t go against the Supreme Court, turns on the phrase “other than” – if that doesn’t make you think the words you choose to use matter I don’t know what will.

In the Nobelman case, the Debtors owed $71,335 to the bank but stated the value of the property as $23,500. The Debtors argued that the bank’s security interest should be changed from $71,335 to $23,500. This argument is based upon section 506(a) of the bankruptcy code which states a claim is “a secured claim to the extent of the value of [the] property.”

The Supreme Court noted that the Debtor’s were correct with their interpretation of 506(a) but why ultimately the 2nd mortgage was still valid and owed was because 1322(b) focuses on a lender’s rights and not necessarily the dollar amount. The rights of a lender are determined by the contract; typically in Texas, this means a lender can foreclose on a property, accelerate the note, and sue for a deficiency balance – none of those rights can be modified through bankruptcy. Living in Dallas, the Texas state bankruptcy laws have a big impact.

Securitization

The legal arguments surrounding 2nd mortgage charge-offs can get very complicated and are too nuanced to attempt to explain to the lay person, but this is the foundation for why $71,335 is still owed even if the value of the property truly was $23,500.

Bankruptcy, through its discharge (forgiveness of debt), does end the lender’s ability to sue a debtor personally for collection of the debt. So why does that mean that a person never has to pay a credit card again but would have to pay the 2nd mortgage? The difference is a legal concept called securitization. A credit card is unsecured – it is attached to nothing. A mortgage is attached to property, so even though personal liability is forgiven through a bankruptcy, securitization keeps the lien attached to the property. This is why, if and when the property is sold, the lien still needs to be paid in full regardless of any 2nd mortgage charge-offs.

Contact WLG in Dallas, Texas for bankruptcy help and other legal financial counsel today. For more reading catch our blog on securitization and stripping 2nd mortgages in bankruptcy!

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