Homes lost, but some second-mortgage debts remain

By: Carolyn Said, Chronicle Staff Writer

Eleven days after losing his home to foreclosure, Jorge, a Napa construction worker, received an ominous letter in the mail. It said he still owed $78,000 on his home's second loan.

"I was afraid and felt pressured," said Jorge, who asked that his last name be withheld because he is embarrassed about his situation. "I called them to say I had already lost the house in a foreclosure," he said, speaking in Spanish through a translator. "They told me it doesn't matter, you have to pay the money anyway."

Jorge's experience is being mirrored elsewhere. Debt collectors are starting to hound people who lost their homes to foreclosures or short sales over their second mortgages.

In California, a foreclosure generally wipes out the borrowers' obligation on the main mortgage but not necessarily on other home loans.

"We've seen a lot of folks coming to us, saying, 'I was foreclosed on, now these people say I owe $150,000 for my second loan; I thought everything was going to go away, what do I do now?' " said Noah Zinner, an attorney with Housing & Economic Rights Advocates in Oakland.

Some experts think the trend will accelerate, causing foreclosure pain to linger.

"I think the other shoe is going to drop soon," said Shannon Jones, a real estate attorney in Danville who gets several calls a day from people concerned about their liabilities post-foreclosure. "In the next two years we will see a huge volume of (debt collection on) second loans. We're seeing a number of lenders start filing suit or turn them over to collection companies."

California is a nonrecourse state, meaning lenders cannot pursue borrowers for unpaid balances on home-purchase loans. However, home loans not used for the purchase - home equity lines of credit and second loans taken out after purchase - are recourse loans, which means lenders are legally entitled to collect the unpaid balance. Depending on the type of loan, they have four to six years to pursue borrowers, Jones said.

Pursuing borrower

Refinanced mortgages do become recourse loans, but in California a nonjudicial foreclosure - the most common kind - eliminates the borrower's liability to the lender that carried out the foreclosure, which is generally the main lender. A second lender for a nonpurchase loan, however, still has "recourse," or the right to pursue the borrower.

In Jorge's case, he took out the second loan to buy his house, so it is nonrecourse debt, and he cannot be sued for the unpaid balance. A debt collector can, however, ask him to pay "voluntarily."

Class action planned

For several months, Jorge continued to receive letters and phone calls from both his bank and a debt collector asking him to pay.

"The servicer says there is nothing that prohibits the borrower from voluntarily paying us," Zinner said. "There is no question it's sneaky, but it's not illegal for them to do that. If they were to threaten to sue, that would clearly be illegal."

"I suspect they're just dealing with volume," said Maeve Elise Brown, executive director of the Oakland group. "(Debt collectors) buy the debt for 10 cents on the dollar and figure they'll browbeat a certain percentage of homeowners into paying them, whether the money is lawfully due or not."

Housing & Economic Rights Advocates has partnered with attorney Will Kennedy of Santa Clara to represent Jorge and plans to pursue a class-action case on behalf of other borrowers with nonrecourse loans whose lenders dunned them for that debt.

"Many people are in Jorge's situation and don't realize they're under no obligation to make any more payments after a foreclosure," Kennedy said.

Loans after purchase

But millions of borrowers do have recourse loans that they took out after purchase, which means lenders have a legal right to pursue them for unpaid balances.

In California during the boom real estate years - 2005 to 2007 - homeowners took out 2.88 million home equity lines of credit and 1.18 million nonpurchase second loans, according to First American CoreLogic, which tracks loan data. The total was 4 million such recourse loans totaling $485.3 billion.

Some experts think lenders may pick whom to pursue by probing defaulted borrowers' net worth.

Rick Harper, director of housing at Consumer Credit Counseling Services of San Francisco, which staffs the federal HOPE for Homeowners hot line, said his workers tell borrowers who are considering default that their second loans could make them liable to debt collection.

"Depending on what the holder of that note wants to do, it can make their (the borrowers') life miserable," he said. "Most of the (lenders) do an asset test to see if there's anything there. They can run credit reports, use investigative services, get their hands on the applications they used when they applied for a loan." Applications for loan modifications and short sales also require disclosure of assets.

Banks check assets

At Wells Fargo, Mary Berg, a spokeswoman for the Home Equity Group, said in an e-mail: "On a case-by-case basis, after a review of the borrower's situation, we do sometimes pursue deficiency balances in states that allow this type of activity. We only pursue deficiency judgments if we determine that the borrower has the ability to repay the entire or a portion of the balance."

Wells, Bank of America and JPMorgan Chase hold the lion's share of U.S. second liens, according to Inside Mortgage Finance. BofA has $147 billion, Wells $124 billion and Chase $118 billion, it says.

Chase wrote off about $4.6 billion in home equity loans in 2009, and has said it expects to write off up to $5.6 billion of the loans this year.

Chase declined to comment. BofA did not return requests for comment.

Jones, the Danville real estate attorney, said she's turned down some second-loan clients.
For instance, one Bay Area man had borrowed $52,000 on a home equity line of credit for a home that ended up in foreclosure.

"The lender filed suit against him and he asked me to defend him," she said. "I said, 'You don't have a defense. You borrowed the money, you spent the money. You signed a promissory note and said you would pay it back.' "

Often, such borrowers end up settling with the lender for pennies on the dollar, Jones said. "You can't get blood from a turnip," she said.

Bankruptcy option

Margot Saunders, an attorney with the National Consumer Law Center, said bankruptcy may be the best option for some people to wipe out liability for their second loans.

"People with a second mortgage who are facing foreclosure should go to bankruptcy to get rid of the unsecured second-mortgage note," she said. "They should do it as soon as they're foreclosed upon, because that's when they're at rock-bottom, not when they've started to rebuild (their finances)."

Other attorneys said borrowers should try to discharge their second liens before a foreclosure or short sale by offering the lender a percentage of the amount due.

Home Affordable Modification Program, the government's foreclosure-prevention plan, recently added provisions encouraging lenders to settle or modify second loans. If adopted by lenders, that could help people who lose their homes in the future avoid pursuit by debt collectors, but it won't do anything for the millions who already lost their homes in recent years.

"It will be hard for people in our state to start over again, if they sometimes lawfully and sometimes unlawfully end up getting pursued for pretty significant-sized debt," Brown said.


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