The credit bureaus are worried about the $265 billion of home equity lines of credit (HELOCs) that will enter repayment mode in the next few years, and so am I.
Many American homeowners made it through the Great Recession unscathed (for the most part at least), but are now sitting on a HELOC that is about to enter repayment, and their monthly interest-only payments are about to get loaded up with principal – a significant burden for their household budget. These are homeowners who, at first glance, seem like they're in a good spot with their mortgage – they're up-to-date on their payments and are making it work every month. But their HELOC may not be in such good shape.
I've previously discussed how this HELOC and second mortgage repayment problem could prompt a new wave of foreclosures: HELOCS will reset to higher payments, putting new homeowners at risk and homeowners already in default could unexpectedly find themselves facing foreclosure, after long years of silence by the original lender. This type of scenario is more likely to occur when the defaulted loan has been bought by an investment company, commonly called a debt purchaser.
We're not talking about situations where Bank A was sold to Bank B, but rather the acquisition of the debt by a smaller firm that is not a bank. These companies acquire the "paper" for perhaps pennies on the dollar, if that much, and with that purchase comes all the rights associated with that financial instrument, including the right of foreclosure as per the terms of the original contract.
How the Sale Increases the Odds of Foreclosure
In my experience, it's far better to resolve a defaulted second mortgage or HELOC with the original bank or lender, before it gets sold to an investment firm. A "surprise" foreclosure can certainly happen when the original lender has determined that the home is now worth enough to justify the move. However, the sale of the unpaid loan to a debt purchaser could greatly increase those odds.
It's common in the business world for one company to sell a financial asset to another, so it's important to understand that there is nothing illegal about companies acquiring older defaulted mortgages and then attempting to make a profit on those loans. That said, it should also be clearly understood that these firms are in business to generate profit, and not to help people stay in their homes.
The collection tactics used by some debt purchasing companies are very aggressive compared to the major bank creditors, and tales of financial hardship are of little interest to them. We're talking about firms that are ready and willing to take homes away from people via foreclosure, regardless of their situation or status. The attitude is, "Pay up or get out."
With this type of creditor, foreclosure is just part of the collection toolkit. A notice of foreclosure places enormous pressure on the homeowner and quickly gets them on the phone with the company that now owns their second loan or HELOC. The options typically being offered are very narrow: Hand over the keys now, lose the property to foreclosure later, or send in all your financial data so we can figure out how much per month you can afford to start paying us.
In some cases, all talk of settlement is refused, and the demand for full repayment is quickly backed up by a foreclosure action to get the message across. This appears to be a clear trend in the industry, and I'm predicting that it will only get worse as more of these older defaulted loans are acquired.
To make matters worse for consumers, the dynamics of the risk calculation completely shift in favor of the purchaser and against the homeowner. When a debt buyer pays $3,000 for a mortgage loan worth $100,000, they're not risking much. It still costs such firms money to foreclose on a home, but their overall risk is quite low per account. Most people on the receiving end of a foreclosure notice will start resuming payments again in order to put the fire out.
It's vitally important for homeowners to understand that there is a huge difference between trying to settle a defaulted second mortgage with the original lender and an extremely aggressive debt buyer. I've talked with heartbroken people who passed up good opportunities to resolve their second mortgages with the original bank or lender, sometimes for 10% to 15% of the balance, only to see the loan get sold to a purchaser refusing to accept less than 50% to 75%.
I've even seen situations where the pending foreclosure action made no logical sense, simply because the home was still fully underwater, leaving nothing for the firm that bought the second mortgage to recover post-sale. Why would a company still proceed with foreclosure when there is nothing to recover? The short answer is to show they mean business and are not bluffing about following through on foreclosure. If you buy 1,000 of these loans at the same time, and you're solely focused on making profit, then it actually makes sense to "invest" some money foreclosing on a few properties here and there, even if it means losing money on those specific properties. The idea is to let people know the foreclosure threat is not a bluff, and thereby increase the overall return on the portfolio.
What Can I Do?
If you're uncertain where things stand with your unpaid second mortgage or HELOC, and you have not heard anything from your lender in a long time, then a good way to gauge the risk of foreclosure is to look at the value of your property at today's prices. Compare your home's current value to the balance still owed on the first mortgage alone. See whether your home is still fully underwater, only partly underwater, or has moved back to positive equity territory. Homeowners in the last two groups may face greater risk, as I explained in a recent article.
Your next step is to look on your credit report to see how the defaulted mortgage is being reported. (You can pull yours for free once a year at AnnualCreditReport.com or get your credit scores for free each month on Credit.com.) Is the original lender continuing to report the default as an unpaid charge-off? This is generally a sign that they are still the owner of the mortgage and it has not yet been sold off to a debt purchasing company.
Another indication that your loan is still with the original creditor is the lack of any notice from your county records office that the second deed has changed hands. Before a debt purchaser can proceed with any foreclosure action, they have to file documentation on the ownership change at that office.
If you're still dealing with the original creditor and wish to resolve the defaulted mortgage, then a phone call to the bank or lender will usually be routed to their recovery department. From there, it's a matter of haggling the best possible deal you can, ideally as a lump-sum amount paid on the condition that the lien is removed.
Be aware that there may be tax consequences to the cancellation of mortgage debt as well. See IRS Publication 4681 for details, or consult your tax adviser for input on whether a settlement would yield a tax burden in addition to the settlement payment to the creditor.
If you are not in a position to settle, then another option is to reinstate the loan. If you are still in a financial hardship situation, it may be possible to negotiate modified terms that you can manage.
Please do not assume that it's safe to continue ignoring a defaulted second mortgage or HELOC. Evaluate your situation, develop a game plan and take action to protect your home from a possible foreclosure.
This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.