I had a reader write in and ask me the following question. He asked, "Richard, can you offer any additional insight when a short sale involves two lenders.  Let’s say, for example, a homeowner has a first mortgage of $350,000 and a second of $100,000. The home has been put under contract, subject to short sale approval, for $300,000. End result, second position mortgage gets wiped out, and first position mortgage now needs to accept less than what is owed." Sent in by someone I'll call Keith.
 
Keith wonders if "this a workable scenario to relieve a homeowner under terms of a short sale?   Will the second mortgage holder really just forgive the entire debt?"

Keith, this is a great question. (And if you like this information, instantly subscribe to my privacy-assured list now.)

 
First of all, how would a sale wipe out the second? A foreclosure would wipe them out but a sale would not. They would still have a lien on the property. If you sell a property that has a first and second mortgage, even if the first mortgage holder forgives the first mortgage, that does not affect the second. There is still a mortgage on the property — the second mortgage.

However, let's look at what would happen in a foreclosure sale situation, a sherriff's sale or trustee sale. In that scenario, assume the first mortgage holder is doing the foreclosure. At the end of the trustee sale, the second mortgage is wiped out.
 
Even in a finalized foreclosure sale, such as a trustee sale, the second will get wiped out — but that doesn't mean they'll just forget about the debt. They still have a claim.

If they don't foreclose, because they left it to the first mortgage holder to foreclose, the second mortgage holder is still left with the option of exercising another remedy instead –suing for breach of contract.

Check the statute in your state…it's four years in California for instance.

I expect a lot of these suits to be brought because they are very easy to win. Of course, they are unsecured obligations and can be discharged in chapter 7 bankruptcy or partially paid in chapter 13 bankruptcy.

Note that if you have significant equity, the second mortgage holder may reinstate the first. They may make all your past payments and delinquencies up to the first by advancing the first mortgage holder the entire past due amount. Then they pursue you for that. They may file the notice of default and they may foreclose. If they get the property back at trustee's sale, then that property will still have the first mortgage on it. But if there is significant equity, the second mortgage holder will foreclose instead of being wiped out.

Today, so many people have little or no equity, that second mortgage holders are often not foreclosing. The second mortgage holders do not want to advance all the payments and fees to the first mortgage holder because that is throwing more good money after bad. But as I said, there is the "one remedy" rule — so if they do not foreclose, and if they get wiped out, the second mortgage holder still can pursue the remedy of suing you in civil court for breach of the note.

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