Underwater Refinance of 1st and 2nd Mortgage

by Ned M. from Milwaukee, Wisconsin

Ask Kate about an underwater refinance of 1st and 2nd mortgage with a bizarre twist: Kate, I purchased an investment property in 2003 for $60,000 cash. After finishing the renovations, I financed it through a major bank with an $80,000 Home Equity Line of Credit (HELOC). In 2005, I did a cash-out refinance with a 30 year fixed rate mortgage. I had more than 20% equity, so I had no mortgage insurance and the loan was sold to Freddie Mac (FHLMC).


Ned continues... I've done a lot of closings and everything was went fine, (except the loan broker wanted to charge me a fee for rescheduling the closing, which was done for their convenience not mine). Anyway, 6 months after the closing, I received a statement for my HELOC and was surprised to see "available balance of $80,000" and a "credit balance of $500".

I went to my HELOC online account and saw the payoff payment by the title company, but the loan was never cancelled and I never received a lien satisfaction. When I called the bank, they said it would cost $500 to close the account, because I was cancelling it within 3 years.

I asked, "When the payoff was requested by the closing agent and they requested a satisfaction, why wasn't it closed and a satisfaction sent?" They said, only I can close the account.

I had a title company do a title search after 5 years and it stated the Home Equity Line of Credit is still in first lien position. I called the loan servicer to let them know and they said it was my problem or the closing agent's. They didn't care. I called the closing company and they said, they did everything they were supposed to do and that I should call the servicer back.

So, when the financial crisis hit, I used the $80,000 HELOC. The property is now worth $80,000 and I have a HELOC (which became the 1st) for $80,000 and the FHLMC mortgage (which ended up a 2nd) for $102,000.

What should I do? It is still an investment property, but I could move into it and make it my primary house since I am selling my primary residence. Can I get a loan balance reduction? Should I walk away?

Kate Answers: Underwater Refinance of 1st and 2nd Mortgage with a Bizarre Twist

***zz-portrait-left.shtml*** Dear Ned,

First the nitty gritty of mortgage pay-offs.

Paying off a 2nd mortgage line of credit, also called a HELOC, is not necessarily dependent upon closing it.

But it's the mortgage company that calls the shots on paying it down, or paying it off, and possibly even closing the line of credit.

So depending on the loan-to-value parameters of your mortgage program, it may not have been a condition of your refinance to close the 2nd, only to pay off the balance. As I already said, paying off and closing are not synonymous.

Sidebar: Most homeowners prefer to keep these HELOCs open so they do not incur the cost and hassle of applying for another 2nd. In fact, they'd consider you were a lucky duck. But that's another story for another day!

Meet the Watchdog errr.... I mean Escrow

Now what about the escrow company? Escrow does not get to call the shots as opposed to the mortgage lender. If the lender tells them to pay off the 2nd, they cannot close your transaction until the funds are released. So they most likely were not passing the buck when they told you they fulfilled lender instructions by merely paying it off.

On the other hand, if the 2nd was to be closed, they are responsible to carry out that action. Go here for more about the duties of escrow companies - How to Get a Mortgage - Meet Escrow .

What I find odd, but not an oversight unheard of, is that the lender did not R-E-Q-U-I-R-E (in big bold print) the line of credit to be subordinated at the time of recording the refinance documents.

This is an enormous deal! Because at this point, if you were to default on your mortgage payments, the owner of the HELOC, which accidentally slipped into 1st position, could be the only party to recover any of their investment. In addition, when Freddie Mac discovers they are in the unenviable 2nd position, they are not going to be happy campers.

Okay, enough shop talk and sorry for the lingo. I try not to do that! What should you do, you ask?

Home Affordable Refinance Program Occupancy Status

Of course, you know I can't give you specific advice. But keep in mind the November 2011 HARP II Eligibility Requirement Announcements of Home Affordable Refinance Program included rental properties.

However, moving back into the house (changing occupancy) would also not automatically exclude homeowners from using HARP.
Is there any requirement that the existing mortgage and the new mortgage represent the same occupancy? No. The occupancy of the subject property may have changed by the time of the new mortgage transaction. -- Home Affordable Refinance FAQs
To be on the safe side and prepare for a successful refinance, I would consult the most reliable mortgage professional to walk you through your specific options, especially since you are refinancing a 1st and 2nd mortgage with a bizarre twist on title.

I hope I'm wrong but I suspect the reversed positions of the 1st and 2nd mortgages are probably going to create some havoc. So get the best mortgage lender on your side.

Home Affordable Foreclosure Alternatives (HAFA) Program

No one likes to discuss walking away from a home. But undeniably, it has become an option for homeowners. In fact, Making Home Affordable (MHA) has developed programs with this in mind.

Under the Home Affordable Foreclosure Alternatives Program (HAFA), there are two options. A deed in lieu of foreclosure (DIL) and a short-sale. Using HAFA for either can result in more protection to the homeowner and in some cases, cash for relocation.

Read more about Home Affordable Foreclosure Alternatives Program (HAFA) at Special Edition Making Home Affordable Options.


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Best wishes,

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