The reality faced by the secondary loan market is that housing prices have fallen. This means in many cases there is no longer enough equity in the property to cover both the primary loan and the secondary loan amounts. In the event that a debtor defaults, instead of foreclosing on the home and forcing a sale the junior lenders are looking to other means of mitigating the damage. They may write the failed loan down as a loss, sell the debt at a discount, negotiate with the senior lender and other solutions. Consequently, financial institutions and banks are constricting their lending practices. This includes reducing open lines of credit on equity, forgiving the interest, selling the mortgage to third parties and other remedial measures. The problem with foreclosing is that the junior lender may lose all of the principle on the loan. Many of the primary lenders will negotiate buyouts of the secondary loans in an attempt to protect their own interest in the property. The Wall Street Journal reports that lenders are rethinking home equity loans (titled the same). So what does it all mean?
Lenders are concerned that borrowers will recognize the dilemma faced by the junior lien holders and lose all incentive to pay the secondary loan. The principles behind the transactions and problems faced by the secured parties are good illustrations how secured transactions function. Under-capitalization generally upsets the secured interest because the debtor no longer has incentive to honor the obligations. The junior lien holder is in a weaker position than the senior lien holder. The strategy employed by the junior lien holder varies by the situation because foreclosure hurts the junior creditor more than it helps them. This potentially frustrates the interests of the senior creditor because the junior lender is more likely not to act on a loan default sitting on what equity would be available to refinance the primary mortgage. This inaction increases the odds that the primary loan will also slip into default.
The economic pressures that the failed secondary loans place on our economy hit in a few ways. One way is because our tax system absorbs part of the bad debt as a reduction in the lender’s tax liability. Another indirect impact is through consumer debt. The consumer market suffers from tougher lending criteria and higher interest rates from primary and secondary loan products. The regimented race notice legal method of filing seems appropriate to deal with the problem because some order must be used to manage the chaos defaulting debtors leave behind. Priority helps the creditors manage the risk and understand the consequences of their relative positions. Business thrives when there is certainty in the market. The practice helps to keep the cost of borrowed money down even during a downturn in the market.
Filed under: Real Esate Law Issues | Tagged: Banking Law, foreclosure, Real Estate, Secured Transactions
