The effects of the housing bubble have been felt by just about everyone, and lenders are certainly no exception. And while “cutting one’s losses” brings joy to virtually no one, lenders are learning just how critical the timing and art of negotiation can be in realizing the best possible outcomes out of an imperfect set of scenarios.
With a rash of so-called “80/20” mortgages working through the foreclosure process, a unique question has arisen regarding the priority of these dual mortgages. In a typical “80/20” transaction, the lender made two loans to the borrower, secured by two separate mortgages—one for 80% of the purchase price and another for the remaining 20% of the purchase price. The funds secured by both mortgages were used to purchase the properties and the mortgages were usually sold on the secondary market.
While the loan documents usually stipulated that the 80-percent loan was entitled to first priority and the 20-percent loan was entitled to second priority, the mortgages were not always recorded in this order. In a foreclosure, if these mortgages were filed out of the stipulated sequence, there is a question as to which lender should be given priority in recouping its investment when the home is eventually sold.
Two rules are in play here: First, the traditional statutory rule that the first recorded mortgage is entitled to first priority; second, common law rule, which provides that the lender who provided the “purchase money” for the original loan is entitled to first priority. Conflicts between these rules have nagged at Michigan courts for years, but they are exacerbated when, in the case of 80/20 loans, a home is financed at 100% of value, so that, technically all of the money lent was “purchase money.” So which lender has the priority?
Winning By Not Losing
The law is unsettled in this regard. As a result, litigation outcomes are very difficult to predict. Keep in mind that, during a foreclosure of a home that lost value during the Great Recession, there will likely not be enough money from the eventual sale of the home to make both lenders whole. So as lenders consider fighting the priority battle in court, they should know that it may be expensive to litigate, there is no guarantee of outcome, and there may be not be whole lot to fight for in the first place.
We often recommend to lenders pursuing foreclosure that they negotiate over priority as soon as possible with any other lenders. By assessing and addressing what the likely eventual outcomes may be, negotiating early on in the game is likely to provide the most efficient outcome.
While cutting your losses may not seem like the bravest course of action to take, in these imperfect scenarios, it is most often the wisest. Negotiate with the other party now, rather than fight them in court later, only to be disappointed by the unpredictable outcome…and potentially much worse for the financial wear.
To learn more about negotiating priority for lenders, contact Stephen McKenney via email or call (248) 594-5252.
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