Power of 2nd Place

The Wall Street Journal (1/16/08) “Lenders Rethink Home-Equity Loans” does an excellent job of explaining lenders’ strategies for managing home equity lines of credit and defaults. First, most lenders are re-evaluating each borrowers credit and collateral (home value) before releasing any additional money under existing lines. Second, banks are preemptively notifying customers that their credit lines have been reduced for the same reasons.

Second mortgages present both perils and power to the lenders. The lender must write down defaulted loans to zero, but foreclosure is not often viable. In many cases the borrowers’ equity does not even cover their first mortgage, and the lender would have to buy out the primary mortgage holder to collect. However, the second lien holder has the power to move to the first position in a refinancing. This is creating difficulties for first mortgage holders.

The prevailing strategy is not to foreclose, but retain a lien on the property which must be satisfied if the property is sold. Therefore, the primary mortgage holder must negotiate with second lien holders in any workout that involves a short sale or refinancing. Obviously, the first mortgage holder can foreclose without regard to any other lien holders.

From a practical standpoint, defaulted home equity loans will continue to accumulate interest and penalties until the house is sold. It is likely that a large secondary market will be developed to trade these markers.

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