Wow! I have been a real estate attorney for thirty years and for perhaps the first time a real estate legal issue is making the news:
Can a first mortgage be refinanced or modified without the consent of the second mortgagee?
President Obama unveiled his $275 billion housing bailout yesterday, the core of which is mortgage modifications or refinances of first mortgages. But apparently there is no provision for dealing with second mortgages.
First some background. A first mortgage simply means that it was recorded first in the Clerk's Office in the Town, City or Country where a piece of real estate is located. This first recording has significance however because in the event of a foreclosure, this mortgage must be paid off in full (including interest arrearage, fees and costs) before any subsequent mortgage receives anything. That is why interest rates on second mortgages (or thirds or fourths) are higher than the rates on first mortgages, i.e. the risk is higher on a subordinate mortgage.
To a large degree the housing boom of the last five years was fostered by 100% financing which often took the form of a first mortgage and a second (or "piggyback") loan. So, many people who houses are under water today or, who are in financial duress have both first and second mortgages recorded against their property.
So, here's the big question again:
Must the second mortgage holder (the second mortgagee) approve a modification or refinance of the first mortgage? In other words, can the second mortgagee hold up a modification or refinance?
Let's start with modification. Certainly any change in the first mortgage that negatively impacts the second mortgagee should require its approval. But, the President's housing bailout only reduces the risk of the first mortgage, i.e. by lowering interest payments, spreading out the amortization or reducing principal. In other words, the second mortgagee is not impacted. I believe that most real estate attorneys would agree that in these cases the second mortgagee's approval is not necessary.
More problematic is the refinance scenario. In this situation an existing mortgage is being released from the land records and a new mortgage (refinance) is going on the land records. By definition, once the existing first mortgage is released, the old second mortgage becomes a first mortgage. Any new mortgage would then be subordinate to the old second. In this situation, the refinance could only proceed if the second mortgage was released OR, if the new loan was actually a second mortgage. In other words, in the refinance scenario the second mortgage is in play and the second mortgagee has to be dealt with - which could hold up refinancing.
Here is one suggestion: treat refinances as modifications. Instead of releasing the existing first mortgage from the land records, assign it to the new lender who is making the new loan. In this way it never leaves its first position on the land records. Then, so long as the new loan does not increase the risk to the existing second mortgagee, in my opinion, the second mortgagee does not have control over the process. In effect, the existing first mortgage is just being modified.
This is great. After thirty years of real estate lawyering, I finally have a meaty legal issue to opine about. Yes, you are right, real estate lawyers lead a sheltered life.
Jim Randel is the founder and co-author of the Skinny On: series. His most recent book The Skinny On Credit Cards: How to Win the Credit Card Game is available at www.JimRandel.com