When your second mortgage is preventing you from getting mortgage help

By Gina Pogol
Mortgage Credit Problems Columnist

Times are tough. Credit scores are down, home equity has been lost and folks with home equity loans are hit harder than most homeowners. Why? The presence of a second mortgage plus bad credit could keep you from refinancing your mortgage. A second mortgage could also derail your short sale attempts and your mortgage modification applications.

Why a home equity loan can keep you from getting mortgage help

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A home equity loan (second mortgage) makes it harder for you to refinance a bad credit first mortgage because it reduces the available equity in your home. With drops in home values over the past years, the home equity loan may be pushing you underwater, meaning you owe a combined total that is more than your home is worth.

If you have a bad credit mortgage and not a Fannie Mae, Freddie Mac or FHA home loan, there is no special refinance program for you. And if you have a home equity loan to boot, the lender can make it very difficult for you to negotiate a short sale or modification.

With a short sale, the buyer makes an offer, which the first mortgage lender may approve. That lender then offers the home equity lender a small amount to remove its lien and let the sale go through. However, most second mortgage lenders hold out for more, and the sale dies. In case of modification, the first lender generally wants the second lender to share its loss; if the second lender says no, the modification falls apart, and you may end up in foreclosure.

How to unload the second mortgage

Sometimes it's good to be underwater. If the total of your combined mortgages exceeds the value of your home by more than the balance of the second mortgage, you may be able to have the second mortgage removed. You have to do it in bankruptcy court, and you have to file Chapter 13 and not Chapter 7 bankruptcy protection.

Here's an example of how a second mortgage can be removed: Let's say you own a home worth $120,000. You have a first mortgage of $125,000 and a home equity loan of $10,000.

That means there is $135,000 of total mortgage debt and only $120,000 of home value. The difference is $15,000; your second mortgage balance is $10,000, which is less than $15,000. In a situation like this, the second mortgage can be taken off the property. This is called "lien-stripping."

You can't be a little bit pregnant, and a lien can't be a little bit strippable. The second mortgage must be entirely unsecured by home value. If, in the above example, the first mortgage was $115,000 and the second loan was $25,000, the second mortgage would not be strippable. The home equity loan balance of $25,000 would exceed $20,000, the amount the home is underwater.

If you think your home equity loan is strippable -- and that taking the step of filing Chapter 13 bankruptcy protection may be what you need to get your feet under you -- consult a bankruptcy lawyer to see if this is the right course.

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