Jingle Mail and 2nd Mortgages

I’ve discussed Jingle Mail several times, which is when a borrower owes more on his mortgage than his residential property is worth, and makes the rational decision to give the house back to the bank by mailing back the keys of the house to the bank.

I’ve been e-mailed and asked via blog comments on what the law is for jingle mail and second mortgages in California. The key question is “Can the banks come after me for the difference between the mortgage price and the market price of the house.”

Let’s have a look at how the law plays out under several typical situations.

In the following examples I use the shorthand “H” for homeowner and “B1, B2″ for Bank 1, Bank 2, and so on.

Scenario 1

In 2006 H purchases his residence for $1,000,000. He pays for the house using funds from three sources: (1) a traditional first mortgage for $800,000 from B1; (2) an additional 5-year-ARM for $150,000 from B2; (3) a $50,000 down payment from H’s savings.

The value of H’s house, however, has now dropped in 2008 to $700,000, and he still owes $920,000 on his two mortgages. He decides to stop paying both of them, and the two lenders foreclose, and sell the house for $700,000 at auction.

Can either B1 or B2 go after H for their shared $220,000 loss on the mortgage?

Answer:

No. In this simplest scenario, the borrower is completely protected. He can walk away from his house, and the banks have no remedy other than foreclosing on the house. They cannot sue the borrower, and cannot go after his other assets. California provides no remedy for banks other than foreclosure on purchase money mortgages on residential real estate when the borrower lives in the house.

Scenario 2

H has two mortgages:

- 1st mortgage from B1 that he used to buy his house

- 2nd mortgage from B2 he took out a few months later.

H stops paying first mortgage to B1, which responds with a  non-judicial foreclosure of H’s house. After H moves out and the house is taken by B1, H stops paying his second mortgage to B2. Can B2 go after H’s assets in a judicial foreclosure?

Answer:

Maybe. It was B1’s decision, not B2’s, to proceed with a non-judicial foreclosure for the obvious reason that the slower and more costly judicial foreclosure process would not get it any better a result because the first mortgage was a purchase money mortgage.

But the 2nd mortgage was not for purchase money, so B2 does have a reason to prefer a judicial foreclosure because it could obtain a deficiency judgment. As the California Court of Appeal noted in In re the Marriage of Anthony and Charlotte Oropallo:

It is true that when the security of a second deed of trust is rendered valueless by a prior foreclosure, through no fault or action of the second lender, that lender for equitable reasons will ordinarily be permitted an action against the debtor on the second obligation.

Note, however, the qualifications the Court uses. It does not say “always” but instead says “ordinarily” may a 2nd non-purchase-money lender pursue a deficiency judgment against a borrower. Note also that the Court says a deficiency action “ordinarily” is allowed when the mortgage is rendered valueless “through no fault or action of the second lender.” The remedy is allowed not as a matter of law, but as a matter of equity, and a bank cannot receive the benefits of equity unless its own behavior was equitable.

H, however, might be able to argue that B2 was at least in part (if not mostly or entirely) for the foreclosure. Is B2 known for seeking out and writing mortgages based on inflated appraisals? Did the B2 target homeowners with poor credit, knowing that it could charge such homeowners higher interest rates and more fees? Did B2 actually verify the buyer’s income, or was it a no-doc loan that it bought from one of the dozens of now-bankrupt subprime brokers? Was B2 already equitably compensated for H’s default by charging and receiving above-market interest rates and a host of fees?

Scenario 2 is winnable by either party, or the decision could be split, with B2 being awarded a judgment for a substantial sum, but less than its full loss. In practice, if H puts up a spirited defense to B2’s lawsuit, H will probably either win the case early by

(1) showing a procedural defect in the foreclosure or B2’s pleadings

(2) or proving inequitable conduct on B2’s part.

Failing that, H will probably be able to convince B2’s attorneys to settle for a smaller sum than the amount he defaulted on.

Scenario 3

H buys his house with a mortgage from B1. Some time later, he takes out a second mortgage, again from B1. He then stops paying both mortgages and B1 forecloses on the house in a nonjudicial foreclosure. The sale of the house does not bring enough to pay off the first mortgage, much less the second.

Since the 2nd mortgage was not a purchase money mortgage subject to the protections of Cal. C.C.P. 580b, can B1 obtain a deficiency judgment for the second mortgage in a judicial foreclosure?

Answer:

No. In Simon v. Superior Court, 4 Cal. App. 4th 63 (1992), a bank tried to go after a borrower in a judicial foreclosure on the second non-purchase-money mortgage after it had already taken the property in a non-judicial foreclosure after a default on the first mortgage.

This is good news for homeowners who have a 2nd mortgage they took out later from the same bank they used for their first mortgage. In many cases a bank may not know the size of a deficiency until after it has already proceeded with a non-judicial foreclosure of the first mortgage. At that point, it is out of luck and will have to eat the loss with the 2nd mortgage (or, quite commonly, a HELOC on top of the first mortgage).

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This article does not constitute legal advice or the formation of an attorney-client relationship, and is not for re-publication without express permission of the author.

Greg Weston is a graduate of Harvard Law School and experienced business attorney licensed in California and Florida. Mr. Weston’s San Diego-based practice focuses on representing individuals and small businesses against large corporations, including cases involving condominium purchase agreements and other real estate investments. He can be reached at (619) 255-7098 or greg@thewestonfirm.com. Comments about the blog via e-mail are welcomed.