From the Sunday, December 20, 2009, Oregonian

 More than two years into Oregon's historic residential real estate crash, an unusual opportunity presents itself to struggling homeowners.

An increasing number of Oregonians qualify to use a rarely utilized bankruptcy court maneuver to reduce, or even eliminate, their second-mortgage or home-equity debt.

To be eligible, homeowners must owe more on their first mortgage than their house is worth. That's an increasingly large segment of the population. Recent studies indicate that 20 to 25 percent of Americans are "underwater" on their home mortgages.

The strategy works like this: Homeowners must first file Chapter 13 bankruptcy and file a motion asserting their home's value has diminished to the point that it's worth less than they owe on the first mortgage. If the motion prevails and the lender doesn't challenge, the court will then cancel the lien the second-mortgage lender holds on the home. The lender's secured debt is converted to unsecured debt, which most often is eliminated in full in the bankruptcy process.

It's not a painless strategy. Filing bankruptcy will significantly damage a consumer's credit.

And the strategy raises issues of morality, for lack of a better word. Many of these homeowners took out second mortgages to buy ski boats, trendy kitchen upgrades and other luxury purchases. Should they get off without repaying the loans? Oregon has at least six banks on the edge of closure after the mortgage crisis of the past year, and this could add to their risk.

Still, with Oregon's foreclosures running at unprecedented levels and the federal government's mortgage modification program proving a cumbersome disappointment, the "second lien strip" strategy could give some over-leveraged homeowners a new path to recovery.

"This is really important, and no one knows about it," said Eric Olsen, a Salem bankruptcy lawyer whose firm has been among the most active in employing the second-lien strip. "I talk to real estate brokers, bankers, even attorneys, it's just not known that you can get rid of your second mortgage."

Olsen's firm successfully eliminated more than $3.8 million in second-mortgage and home equity debt for 75 clients in 2009 and has another 29 cases pending, he said.


Loan industry woes
The second-lien strip is just another lump of coal for the country's struggling financial sector, which already faces significant loan problems on multiple fronts.

U.S. lenders are sitting on nearly $1 trillion in second-mortgage and home equity loans. A maneuver that allows underwater homeowners to walk away from those loans with impunity will only add to the industry's woes.

Critics of the federal bank bailout pointed out the "moral hazard" implicit in the government rescue. They argued that rather than be saved by taxpayers, the big Wall Street players should be left to suffer the consequences of their irresponsible actions, lest they repeat it.

The second-lien strip raises similar issues on a smaller, individual scale. The borrowers got the benefit of the thousands of dollars they promised to repay, even putting up their houses as security.

"They stripped the equity out of their homes to buy boats and take vacations," said Guy Cecala, publisher of Inside Mortgage Finance. "Does America want now to bail them out?"

Though taxpayers aren't footing the bill for this debt reduction strategy, they do pay a significant tab when banks fail.

Olsen countered that as the economy has worsened, it's unemployment and pay cuts, not irresponsible spending, that have pushed many of his clients into bankruptcy.

In any case, some of these second-mortgage lenders have done little to generate sympathy. They made ill-advised loans and some are now making it difficult for struggling borrowers to escape foreclosure.

One of the reasons the Obama administration's Making Home Affordable mortgage modification program has not worked as well as hoped is because of uncooperative second-mortgage lenders. Both first- and second-mortgage lenders must sign off before a customer can get a loan modification.

"They're holding these modifications hostage," Cecala said. "These second mortgages and home equity loans may be worthless on paper. But the lenders still have clout."


A family's struggle
Doug Mackay credits the second-lien strip with saving his family from homelessness.

Mackay puts a lie to the critics' stereotype of second- and third-mortgage holders as high-living deadbeats. He is a truck driver. He and his wife, Susan, lived in a doublewide mobile home in Prineville.

They found themselves in financial crisis in 2007 after their 16-year-old son, Shaun, critically injured himself in a high-speed ATV crash.

"He exploded his liver," Mackay said. "He was in the ICU for 31 days and went through 12 surgeries. The total bill was somewhere around $400,000."

His health insurance covered just 40 percent of the tab.

Then came 2008 and $4-a-gallon fuel, which ate into the self-employed long-haul driver's income.

Unable to pay their bills, the Mackays saw creditors repossess their pickup, their camping trailer and the Volvo semi that was at the heart of their trucking business.

The couple filed for Chapter 13 bankruptcy Dec. 19, 2008. Their bankruptcy attorney, Rex Daines, a partner in Olsen's law firm, suggested the Mackays could rid themselves of their third mortgage.

Mackay had taken out three mortgages against his house in part to fund his trucking operation. The debt on his house, among the three mortgages, totaled $145,033. That made sense when his home boasted a value of $190,000.

But then came the housing crash, which was particularly brutal in central Oregon. Mackay said in his bankruptcy that his house's value had plunged 36 percent, to $120,000.

Mackay's lender, Washington Mutual, did not contest the lower value. That allowed Mackay to strip the lien WaMu held on his house as the third-mortgage lender and convert the $28,500 third mortgage to unsecured debt, which was entirely discharged in the Chapter 13 bankruptcy.

Broadly speaking, there are two kinds of creditors in bankruptcy, secured and unsecured. Secured creditors have a right to repossess collateral put up by the borrower, often their home, if they fail to repay the loan. Unsecured creditors have no collateral.

The point of the second-mortgage strip is that it converts a second-mortgage lender from secured status to unsecured, which the debtor can often shed in full in bankruptcy.

The move helped lower Mackay's house payment by $400 a month, which has allowed him to keep the place. Mackay got a job with a Washington trucking firm.

As long as the Mackays make the $735-a-month payments called for in their Chapter 13 bankruptcy plan, the third mortgage is effectively eliminated. If they fail to make those payments, the third mortgage is once again payable in full.

But Mackay's is not an entirely happy ending. The stress of the couple's financial plight took a toll on his marriage. He has separated from his wife. He and his son now live with his parents in Florence while his wife lives at their house in Prineville.

"I live on the road for $30-a-week food money," Mackay said. "I don't buy anything now unless I have cash."


Lenders stuck anyway
The second-lien strip has been part of bankruptcy law for years. But during the decades of steady real estate appreciation in Oregon and much of the country, it was largely forgotten.

"I've been practicing nearly 25 years, and this is the first time this has been available," said Ann Chapman, a Portland bankruptcy attorney.

The reason, of course, is housing values. The long years of home price increases reversed course in 2008 and prices have plummeted more than 20 percent on average in Portland, and considerably more in some markets.

Other Oregon attorneys have also jumped on the strategy. In the first 17 days of December, more than 20 debtors launched efforts in Oregon bankruptcy courts to strip their second mortgages.

Most of the debtors are using opinion letters from Realtors to peg the new, lower value of their homes. Lenders can contest the value, but rarely do.

"In my experience, they're mostly going unchallenged," Chapman said.

There are at least two reasons for lenders' relative passivity. First, it's impossible to dispute that property is worth significantly less than it was two years ago.

Second, in today's bleak environment, even if a lender successfully shuts down a homeowner's attempt to shed his second mortgage, the lender may be no better off.

Tom Hooper, a Portland creditors' attorney who represents banks, pointed out that even if a second-mortgage lender successfully contests a homeowner's valuation, the homeowner could just give up and walk away from the home, tossing the keys to the lenders.

Then, in the event of foreclosure, the first-mortgage lender, not the second, gets the home or the sale proceeds when the home is auctioned.

"Winning could mean you're losing anyway," Hooper said.




 

 

STEPS TO GET RID OF YOUR SECOND MORTGAGE

1.       You must have two mortgages and want to keep your home

2.       Your home must be worth less than the first mortgage 

a.     Many people have an unrealistic estimate of what their home is worth- they think it is worth more than it actually is worth.

b.      Value is generally determined by what it would actually sell for within 90 days in the current market

3.        You have sufficient income to make the first mortgage payment and money to live.  You stop making your 2^nd mortgage payment- it is being eliminated.

4.        We file a chapter 13 bankruptcy.

a.      Chapter 13  is a bankruptcy where you pay certain of your debts over a period of 3-5 years. 

b.      For example a Chapter 13 can stop a foreclosure and allow you to catch up on past due mortgage payments  (obviously only on the first mortgage since we are wiping out the 2^nd mortgage.)

c.       A chapter 13 can pay past due taxes wiping out penalties and stopping interest.  Depending on the age of the taxes they can also be wiped out.

d.      Other secured debt like cars can be paid through chapter 13 often reducing interest and  only paying what the car is worth

e.      Past due child support can be paid through chapter 13 and student loans are automatically deferred while in chapter 13

f.       In most cases unsecured debts ( credit cards and medical bills) are eliminated and not paid.

5.        After the chapter 13 is confirmed or approved by the court we file an adversary proceeding against the 2^nd mortgage holder asserting the home is worth less than the first mortgage to eliminate the 2^nd mortgage.

a.      The mortgage holder normally will not contest this

b.      If it is contested then we normally are able to negotiate a settlement resulting in a reduction of interest and principal owed on the 2^nd mortgage.

6.        At the conclusion of the chapter 13 you receive a discharge of your debt and the second mortgage debt and lien is eliminated.

 

 

 


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