Your Underwater Mortgage Doesn’t Have to be a Ball & Chain

By admin • August 3rd, 2010

California is a non-recourse state for the first mortgage on a home, meaning that the debt is tied up in the collateral, not the individual.   This means that when the bank forecloses on your home, once you turn over the collateral (your house), the bank cannot come after you for any outstanding debt.

Using an example, say you bought a house in 2003 for $800,000 by taking out a $600,000 mortgage.  You live in the house for a couple of years enjoying relative prosperity and pay off about $50,000 of the mortgage.  Then, tragedy: the real estate market crashes and the value of the home is now $250,000.  $300,000 of your mortgage is now unsecured, which means your house is now an under-secured debt.  Say you then lose your job and cannot make the mortgage payments.  After struggling to make ends meet and defaulting on your mortgage several months in a row, the bank starts foreclosure proceedings and sells your home for $250,000.  Because California is a non-recourse state, once you turned over the collateral (your house), your mortgage lender cannot collect from you.  Even if you had $200,000 in your bank account, the lender cannot touch it.  The lender assumed this risk when they approved your mortgage application, so after you hand over the house you can walk away and live happily ever after.

However, even in a non-recourse state, if you have a second mortgage that you took out after your first mortgage, you are still on the hook for that debt.  For example, say in 2003 you bought the house for $800,000 with a mortgage of $500,000.  You then enjoyed a year of prosperity followed by a few years of hardship.  After struggling to make ends meet, you decide to take out a second mortgage on your house worth $100,000.  Real estate market crashes and the house is now worth $200,000, leaving you upside-down on the house by $400,000.  If you turn over the house, you can walk away from the first $500,000 mortgage, but you’re still liable for the second $100,000 mortgage.  Since you no longer have the collateral, the second mortgage is now an unsecured debt, which you are still liable for.

Most people cannot afford to continue making payments on a mortgage for a house they no longer own.  If you default on your payments, the bad news is that the lender could get pretty aggressive about collecting on the outstanding balance.  The lender can go to court and get a judgment allowing them to collect from you through wage garnishments or a bank levy.  For someone who is struggling to make ends meet, these garnishments or levies can be brutal.

The good news is that unsecured debts can be discharged in bankruptcy.  If you simply cannot afford to continue making the mortgage payments for a house you no longer own—or if you are facing potential wage garnishments or bank levies—call the Doan Law Firm for a free, no obligation consultation to learn about how bankruptcy can alleviate this financial stress.

 

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