Smart Borrower Blog

Walk Away from Debt?

Feb 13th, 2008 @ 12:02 PM by MortgageMentor

Please read “Homeowners Stuck with Low-Value Properties,” my post from yesterday, if you haven’t already. One commonly held theory is this: if you are in danger of going into foreclosure, simply stop paying on part of your mortgage. Here is how this advice goes:

If you have two, three, or more loans against your home, figure out which one is the “senior” loan — the loan that would be paid off first if you were to sell the property. Add up the subsequent loans and, if they are more than the value of the home, simply stop paying on the most “junior” loan.

For example, say your home is worth $325,000. You bought it a couple of years ago for $300,000, borrowed $250,000 as a first mortgage, and took out a second mortgage of $50,000 to make the down payment — a common practice during the glory days of 100 percent lending. After that, you got a $75,000 home equity loan for — well, whatever you wanted to use it for. So now you owe $363,838 on the three loans — and the house isn’t even worth that, and you will pay much more over the life of the loans (15 years for the home equity loan, and 30 for the others).

What these “experts” suggest that you do is stop paying on the home equity loan. The reason? If the property goes into foreclosure, the first and second mortgages are the ones that will be paid first. So there’s no reason for the home equity lender to enforce a foreclosure, as there is no profit in it.

Please understand, this is not my personal advice—it feels completely wrong to me to ditch an obligation to pay. Tomorrow we’ll look at another side of this coin.

3 Responses to “Walk Away from Debt?”

  1. This is a good point, second mortgages are usually reluctant to start foreclosure proceedings, let alone a third mortgage. Obviously, if homeowners are going to fall behind somewhere, then it should be on the least important bills first, like the HELOCs and third mortgages. But even so, it might be better to let that one go until whatever financial hardship has occurred is over, and then negotiate with the mortgage company for more reasonable payments.

    And the third mortgage won’t wait forever — eventually, they’ll force the foreclosure. In fact, they may even put in the winning bid at auction, which will not get their loan paid off, but it will give them a property far under market value that they can hold onto until it is sold. For the little amount that was owed on the third mortgage, it could turn out to be more profitable in the end. But most banks are not property managers, of course.

  2. Chris Garcia says:

    Intersting article. With such a huge portion of the mortgage industry (loan officers) being laid off I hope that the strong that survive will take a better approach and offer better advice for future mortgages. One would assume that the surviving ones are the same that built a solid business as advisors and NOT just out for a quick buck.

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