My first mortgage is in foreclosure...but what about the second mortgage?

During the real estate boom, as property values continued to rise, many borrowers were given equity lines of credit secured by a second mortgage on their property. However, with the sharp devaluation of real estate in Florida, many borrowers are unsure or unaware of the impact of the devaluation in reference to the second mortgage on their property.

The second mortgage is subordinate to the first or primary purchase money mortgage. The first mortgage holder upon default will pursue its foreclosure remedy in order to obtain title to the collateral pledged for repayment of the first mortgage. This is the first mortgage holder’s lawsuit that ultimately divests the borrower of their legal ownership of the real estate and places the title to the real estate in the name of the foreclosing lender. This foreclosure action by the first mortgage holder forecloses subordinate liens, including a second mortgage lien. The second mortgage lender no longer holds a security interest in the real estate that it can look to foreclose to ensure repayment of the promissory note.

So what is a second mortgage holder’s remedy? The second mortgage lender could choose to foreclosure its mortgage, however, it would take title to the collateral (the real estate pledged for repayment of the promissory note) subject to the first mortgage. The second mortgage holder cannot foreclose an interest in real estate that has priority, so a suit on the note becomes a preferred remedy. Upon default by the borrower, many second mortgage holders simply file a suit on the note.

In this case, the second mortgage lender is pursuing a more aggressive and more effective attack against the borrowers by proceeding directly against the mortgage’s underlying promissory note. What this lawsuit entails is a pursuit of a money judgment against the borrower personally. Often the first count of the complaint will be a suit on the note and a copy of the original promissory note executed by the borrower will be attached as an exhibit to the complaint filed by the lender’s attorney. Additional counts may be included by the lender’s attorney, such as, money lent and unjust enrichment. The complaint will then have to be personally served on the borrower. Once the complaint is served, the borrower/defendant has 20 days to respond to the lawsuit.

While the borrower may have affirmative defenses to respond to the lawsuit which may or may not delay an entry of judgment, the most effective way to avoid this judgment would be the filing of a bankruptcy before judgment is entered. Depending on the specific factual circumstances of the borrower/debtor as well as the chapter under which the bankruptcy may be filed the borrower/debtor may discharge this personal money judgment in a Chapter 7 liquidation bankruptcy. A Chapter 13 filing prior to a foreclosure sale occurring may also provide the borrower/debtor with the ability to take advantage of the lien stripping provisions as to the second mortgage or subordinate liens or propose a plan to catch up on the mortgage arrearages.

If the foreclosure has already occurred and the bankruptcy petition is filed under Chapter 13, then the second mortgage lender’s claim could be classified as unsecured. This unsecured claim is entitled to a pro rata share of the total funds paid into a Chapter 13 plan for all unsecured class of creditors and no more. If the original equity line of credit balance was $100,000 and the total paid into a Chapter 13 plan over five years to all unsecured claims is $30,000, then the equity line of credit holder would receive their pro rata share of the $30,000 and no more. Upon a successful completion of the Chapter 13 five year plan, the debtor will emerge from the bankruptcy filing having paid back a portion with the remaining balance discharged in bankruptcy.

Cynthia A. Riddell, is an attorney whose practice focuses on bankruptcy as well as other debt related matters.