Should I pay my second mortgage if my house is underwater?

Should I pay my second mortgage if my house is underwater?

The most common question of homeowners if they have a residence that is underwater is “Should I pay my second mortgage?”  To illustrate, assume that Juan and Maria bought a house in 2006 worth $500,000 with a financing of 80/20 or a first loan of $400,000 and a second loan of $100,000.  The house now has a market value of $300,000.  Under this situation the first loan is collateralized up to $300,000 whereas the second loan has no collateral.  A lender can foreclose in California if the mortgage is not being paid.  In foreclosure actions, lender foreclose only if there if a value in the collateral.  Under this situation the second loan has no collateral because of the reduction in property value.  Only the first loan has collateral.  For practical purposes the second mortgage holder will not foreclose on the house because it will not get any money in doing so.

Question:    How can a homeowner totally eliminate the second mortgage?

Answer:    Filing Chapter 13 Bankruptcy will allow a homeowner to strip the lien on the second mortgage.  The result of lien stripping is that the second mortgage of $100,000 above will be considered an unsecured loan.  Unsecured loan are like credit cards where no collateral is attached to the loan.  In Chapter 13, the unsecured loan will be paid based on the monthly disposable income of the debtor.  If the disposable income is just sufficient to pay secured creditors, the unsecured creditors will only get a minimal percent of whatever is left in the disposable income.

Question:    If I file for Chapter 13, will the lender of the first and second mortgage be able to foreclose?

Answer:    Once you are approved on your Chapter 13 plan of payments which include paying the arrears on the first mortgage over three to five years and continuously paying the current monthly payments for the first mortgage, the lender will not foreclose on your house.  The second mortgage lender will not also foreclose because once the lien is stripped, the loan becomes unsecured.  However, you have to complete the plan payments.  Failure to pay plan payments will cause your case to be dismissed.

Note:    This is for presentation purposes only and not a legal advice.

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