Zombie second mortgages (“zombie mortgages”) can jeopardize your real estate transactions by affecting a seller’s ability to sell their home. If a buyer is counting on equity from their existing home to finance their next one, zombie mortgages can also affect a buyer’s ability to purchase a new home. According to a statement by the Consumer Financial Protection Bureau (CFPB), “zombie mortgages tend to particularly affect older borrowers, lower-income borrowers, and borrowers in communities of color.”
So, what exactly are zombie mortgages and what should you know about them to better service your clients?
What are zombie mortgages?
Zombie mortgages are dormant second mortgages that many homeowners believe were cancelled or forgiven with their loan modifications years ago. Such mortgages owe their origins to a time before the 2008 financial crisis, when many homes were being financed using 80/20 loans. This loan product, sometimes referred to as a piggyback mortgage, required homeowners to take out two loans. One to finance the home purchase (80% of the value of the home) and a second to cover the down payment (20% of the value of the home).
When the housing bubble burst, many homeowners were offered loan modifications to change their loan’s rate, terms, or both to make monthly payments more affordable in the aftermath of the 2008 financial crisis. As part of this modification, these homeowners believed, and in some cases were specifically told by their lending institutions, that their second mortgages were being discharged. When homeowners stopped receiving statements for these second mortgages, they had no reason to question this belief.
In many cases, however, the second mortgages still existed, and were sold to investors (debt collectors) for pennies on the dollar. Now, more than a decade later, these debt collectors are demanding huge payments, sometimes doubling the initial mortgage amount, by adding on years’ worth of interest and late fees to the amount initially owed. Those who are unable to pay are threatened with foreclosure.
Why now?
The surge in home prices has incentivized these debt collectors to crawl out of the woodwork. When a property is foreclosed on, there is a specific priority of how debts or liens get paid. After the property is sold, the first mortgage is typically paid off and anything remaining is used to pay off junior liens.
When home prices collapsed in 2008, there was rarely enough money to cover the first mortgage, let alone the second mortgage. Now that home prices have risen, however, that is no longer the case. If a home gets foreclosed on, the surge in home prices means there is plenty of money left after the first mortgage is paid off to cover the second mortgage.
What can homeowners do?
Homeowners who suspect they may be subject to a zombie mortgage should seek appropriate advice from legal counsel. The specific state and federal collection rules and statutes of limitations that apply can impact a homeowner’s rights and risks with respect to these zombie mortgages. An attorney who practices in your jurisdiction should be able to provide the proper guidance. In some instances, debt collectors may have a legitimate claim to collect or foreclose on a home. In other cases, they do not, or they have not followed the proper procedures, which can be detrimental to their collection efforts.
According to Kristi Kelly, an attorney working at a consumer law firm in Fairfax, Virginia:
Federal regulations require that monthly statements be sent if there is interest assessed on a mortgage. Monthly statements like the ones you get for credit cards and student debt. In many cases, that never happened. The homeowners never received any kind of communication about these loans for years. And debt collectors piled on massive amounts of interest and late fees retroactively. By violating [federal law] they then open themselves up to serious legal consequences and provide consumers the leverage they need to stay in their homes.
What can agents do?
Agents and brokers can help their clients stay protected by encouraging them to seek a title search prior to selling or buying a home. A title search can identify whether any zombie mortgages affect the property, or if any other liens, outstanding debts, or claims affect the seller’s ability to convey the property to a buyer. Such searches are typically done as part of the closing and settlement process, but these services can be procured at any time, such as during the listing phase, so that issues can be promptly addressed to minimize the likelihood of a delay or cancellation of the transaction.
Purchasing title insurance through a reputable company can also provide buyers with greater peace of mind by reducing their risks should any discrepancies or concerns relating to the property’s ownership be discovered later.
