The nation's largest banks might want to take a hint from a recent upswing in Chapter 13 bankruptcies by people who have second mortgages. The four largest issuers of both first and second mortgages, Bank of America, Wells Fargo, JPMorgan and Citibank hold nearly $435 billion of the $1 trillion second mortgage market, and they could face staggering losses if the trend continues.
Mortgage borrowers generally seek loan modifications before even considering filing for bankruptcy. When they face too many roadblocks to debt negotiation with their banks despite government programs like the Home Affordable Modification Program (HAMP), however, they often find that Chapter 13 is a way to keep their homes while ditching unaffordable second mortgage liens.
Bankruptcy Courts Can Reclassify Second Mortgages as Unsecured
In the case of an underwater mortgage, where a home has an appraised value of less than the amount owed on the first mortgage, Chapter 13 can offer an unexpected life raft for some drowning debtors. The homeowner can petition the bankruptcy court to reclassify the second mortgage from secured debt to unsecured, which does not have to be paid in full.
"We're at a unique place in history," said one bankruptcy attorney interviewed by the New York Post. "This is the only time where you see such a huge percentage of houses worth less than the first loan, allowing us to basically get rid of the second loan." That lawyer estimates that 20 percent of his clients who own homes could qualify for a reclassification of their second mortgages in Chapter 13.
Second mortgages are contributing to the foreclosure crisis for a couple of reasons. First, those who have a second mortgage are more likely to be underwater, and thus be struggling to make payments on their first mortgage.
Secondly, the average second mortgage is about 20 percent of the total amount owed, according to Laurie Goodman, who is senior managing director at Amherst Securities Group, a mortgage-bond trader.
Federal Second Lien Modification Program Intended to Help 1-1.5 Million Homeowners
The federal government is moving to address the problem of second mortgages. It announced a new addition to the HAMP program earlier this year: the Second Lien Modification Program. It has been a little slow to get off the ground, according to the New York Post article.
A JP Morgan Chase spokesperson pointed out that it can currently only negotiate with homeowners who have both their first and second mortgages with JP Morgan. That's because government loan matching files to coordinate with other banks won't be available until August.
Still, the four major banks have signed on, and JP Morgan estimates it has negotiated second mortgage modifications with more than 800 borrowers out of about 1,200 who currently qualify. (Overall, JP Morgan holds approximately $114.9 billion in second mortgages.)
"It's not a thing you want to do unless you're desperate enough," said one homeowner who filed for Chapter 13 bankruptcy because he couldn't work out a deal with Wells Fargo. "But I couldn't do anything by negotiating directly with the lender."
Related Resource:
"Liening on banks: Second mortgages are next housing crisis" (The New York Post, July 11, 2010)
