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What Happens to a Second Mortgage on a Short Sale of a Home?

what happens to a second mortgage in a short sale

by Karen Lawson

Mortgage lenders approve short sales for reducing losses associated with foreclosing mortage loans.

How Short Sales Work

Mortgage lenders approve short sales to reduce anticipated losses caused by defaulted mortgage loans. When a home is worth less than the mortgage loan or loans owed against it, a short sale releases the homeowners from their primary mortgage obligation in exchange for the net sale proceeds of an approved short sale. The primary mortgage lender recovers a portion of the mortgage amount when the property is sold. Second mortgage lenders may receive a small payment for releasing their liens against a short-sale property, but they usually aren't permitted to receive payment from the net sale proceeds.

Second Mortgages and Short Sales

Here's an example of a short sale: The primary mortgage lender is considering a market-value short sale of $150,000 for a home with a primary mortgage balance of $175,000 and a second mortgage balance of $10,000 for a total debt of $185,000. After paying the closing costs and real estate commission, the net sale proceeds are expected

to be $138,000, resulting in a loss of $37,000 to the primary lender. The primary mortgage will be foreclosed after the closing date for the short sale. The second mortgage lender requests $1,000 for releasing its mortgage lien. The primary mortgage lender approves this payment to the second mortgage lender after comparing estimated short-sale losses of $38,000 to projected foreclosure losses of $50,0000, and calculates $12,000 net savings as compared to its estimated foreclosure cost.

Mortgage Insurance and Short-Sale Approvals

If the primary mortgage is covered by mortgage insurance (MI), the mortgage insurance company typically approves the terms of a short sale because it's liable for reimbursing the primary mortgage lender for its foreclosure losses. MI companies aren't obligated to approve payments to second mortgage lenders. The primary mortgage lender must await approval by the MI company of short sales for primary mortgages with MI coverage. This can delay a short-sale approval, but the primary mortgage lender risks losing its MI coverage if it agrees to pay a second mortgage lender without approval from the MI company.

Factors Involved in Negotiating Short Sales

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