Can second mortgage lender pursue payment?

Dear Bankruptcy Adviser,
I filed Chapter 7 in 2007. We kept the home and continued to make the first and second mortgage payments. In 2009, we modified our first mortgage, but our second lender was not agreeable to anything and we fell behind on our payments and they sent the loan to chargeoff status. As this loan was discharged in bankruptcy, can they come after us for a judgment? Or if they sell to a collections agency, is the threat of judgment real? We want to settle, but would like to know our rights.
— Diane

Dear Diane,
I find this to be a fascinating question and set of circumstances. This fact pattern is quite common, especially in California, Nevada, Florida and Arizona.

Here is what has happened. You had a first and second mortgage and your home is considerably upside down. That means that your home value was worth less than what you owed on the two mortgages combined. In some cases, the house is worth less than what you owe on the first mortgage only.

For example, you owe $300,000 on your first, $50,000 on the second mortgage, but the house is valued at only $250,000.

You then file a Chapter 7 bankruptcy. Through the bankruptcy process, you do not agree to reaffirm the loans — either the first or second. A reaffirmation agreement is a legal enforceable contract, filed with the bankruptcy court, which states your promise to repay all or a portion of a debt that may otherwise have been subject to discharge in your bankruptcy case.

Since you did not reaffirm the loan, you are no longer legally liable to pay either the first or second mortgage loan. Most clients’ first comment after hearing this is, “So that means the loans are gone and I get the house free and clear.”

That is wishful thinking. The bankruptcy eliminated your legal liability to pay on the mortgage loans, but the lien against the property remains. A lien is a claim against a property by the issuing bank or lender to secure repayment of a debt, typically in the form of a mortgage. Because the lien still exists, but your legal liability is gone, the lender can foreclose on your house, but cannot sue you to make you pay this debt.

This is the interesting part: When would the second lender foreclose on the property? In some cases, the value of the property may take years to come back. You might be working with the lender on your first mortgage and paying it. Since the second can only foreclose on the property, it is unlikely to do so until the house is worth more than what is owed on the first mortgage.

That does not mean you should ignore the second. The lender might continue to report missed payments to your credit reports and thus stall your credit recovery from bankruptcy. But you might be able to settle with the lender. A one-time, lump-sum payment could be enough to satisfy them and get them to release the lien against the property.

Or you might be able to start making monthly payments. If the lender reports future payments to your credit report, you will get the benefit of post-bankruptcy mortgage payments.

So long as you are making payments, or working on a loan modification with your first mortgage, you could have some options to negotiate with the second.

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