After chapter 7 bankruptcy, I often advise my clients, just don’t pay the second mortgage.
Now, if you don’t file bankruptcy and stop paying the second mortgage, two things would happen. They will call you day and night; and eventually they would sue you and garnish you. Bankruptcy keeps them from doing either of those.
Will they foreclose you? That’s the big question. The second mortgage can sell your house to a new homeowner only if they pay off the first mortgage. If the value of your house has dropped below what you owe on the first, that’s just a way for them to lose more money. They are not going to do that.
To put it another way, the second mortgage won’t kick you out of your house just to be mean. They will only do it to make money. If they can’t make money, they won’t do it.
So, what are they going to do? They will wait patiently for you to keep paying the first, and hope the value comes back up (and the balance on the first drops) that at some point you have equity that they can grab.
So, if you follow this just-don’t-pay-the-second strategy, you know you will never have any equity in your house. If you go to sell five years or twenty years down the road, the second will still be sitting there. (With five or twenty years of interest and late fees.)
So when does this just-don’t-pay make sense? Suppose you have five more years before your youngest is out of high school. Once that’s done, you might want to move to a smaller place anyway. Then you can stop paying the first mortgage too, and move out. The bankruptcy still protects you from both of the mortgages. (You’d have to keep paying the HOA until the first mortgage forecloses.)
Does this strategy hurt your credit? It does and it doesn’t. It doesn’t hurt your credit score, because that second mortgage will just show bankruptcy and can’t show any late payments after that. (For my clients, we check to be sure.) But it does hurt your being able to buy again.
For loans like car loans–or interest rates on your credit cards–your credit score pretty much controls, so you’ll be able to get a care loan at a good rate. Your score will be good, if you’ve built up new, good credit.
But to get a mortgage, a different rule applies. The March 2, 2010 manual released by Fannie Mae, (link here https://www.efanniemae.com/sf/guides/ssg/sgpdf.jsp) says what you have to do to get an insured mortgage. You have to be two years after the bankruptcy (with extenuating circumstances), but you have to be three years after a foreclosure. Even though there will not be a foreclosure on your credit report, there will be one on the land records, and a mortgage lender will check there, too.
So if you follow this just-don’t-pay-the-second strategy, you keep the house for three or five or seven years; then you have to plan to rent for three years or so. Then you’d be able to buy again.
If real estate goes up a lot over the next ten years, you’d be better financially to move out of the house right after the bankruptcy, rent for three years right away, and then buy again. (If real estate stays flat, then not being able to buy for ten years doesn’t lose you anything.)
But if you want to keep your children in the same school and the same house, just-don’t-pay-the-second is a good plan.
What if you want to keep this house long term? One way to do that would be with a second mortgage relief Chapter 13. See my website on that. http://virginiasecondmortgagerelief.com/
Or, you can not pay the second for a couple years, save some money, and then offer them a cash settlement. Say you owe $75,000 on the second mortgage, file chapter 7 bankruptcy, and pay them nothing for three years. If the value of your house is still less than you owe on the first, and you offer them $7000 to call it even, they might agree. If you move out, they get nothing.
That strategy takes nerves of steel. And it works best if you go for several years of not paying them–you want them to get used to getting nothing, so your offer of 10 cents on the dollar looks good. I’ve seen it work.
Here’s an example where Chase, after getting nothing for four years, offers to settle at $20,000 second mortgage for $2000. And here’s an example of HSBC offering to settle as $126,000 second mortgage for $12,600.