Sold Out Junior Loans
This thread has been started due to some confusion about the difference between a 2nd or 3rd or other junior loan, and a “sold-out junior” loan. This occasional confusion has been noted on the “Strategy for Settling Your 2nd” thread.
Here’s the difference between the two:
A) A 2nd (or 3rd, etc) is a secured junior loan on a property that has not been foreclosed, i.e. one to which the homeowner still has title. In almost every instance, there is a compelling reason to eventually settle with the 2nd lender. Why? To extinguish (re-convey) the 2nd lien that encumbers the property. In certain rare instances, that need to eventually extinguish the lien may not exist. What are those instances?
1) When the 2nd loan is so underwater that it will take many, many years for the property value to recover enough to put that 2nd clearly in the money. This long time horizon might be longer than the homeowner’s life expectancy.
2) The homeowner intends to live in the property for the rest of his/her life. A corollary to #1 above.
3) The homeowner doesn’t plan to ever sell or re-finance the property.
4) The property owner doesn’t have plans to leave the property to heirs.
5) The homeowner just doesn’t care about it.
B) A sold out junior loan, on the other hand, is a formerly secured junior loan, like a 2nd which was secured by a property that has already been foreclosed. A foreclosure by the 1st lender has wiped out the 2nd’s security, and that former 2nd is now an unsecured “sold out junior.”
1) If that sold out junior was a non-recourse loan (a “purchase money loan” in most states), then the sold out junior lender is legally barred from suing the borrower for any money due on the note. The debtor is protected and has no legal risk.
2) If, however, that sold out junior loan is a recourse loan, then the sold out junior is not legally barred from suing the debtor for money due on the note.
But, the good news is that, heretofore, such lawsuits have been very rare, by any lender in any state.
C) About Settling with a Sold Out Junior
Due to my last statement in B above, I advise borrowers never settle with a sold out junior lender. There are occasional rare exceptions. For instance, a borrower whose employment is conditioned on maintaining a security clearance, which might entail periodic credit reports and background investigations, may want to settle to avoid the risk of losing his/her job.
Occasionally a borrower may feel some moral compunction and want to do “the right thing.” Those borrowers are few and far between, particularly after they learn that their credit file will likely still have a derog reported, despite a settlement.
Finally, settling with a sold out junior lender is always less of a challenge than settling with a 2nd lender. Why? Because a sold out junior is an unsecured lender, and thus has no leverage, and is quite happy to ever see any more money on that note!
Here’s an example. Settling a loan is really buying it back from the lender. Since lenders can sell 2nds on the secondary market for no more than 2 – 5 percent of the loan balance, a borrower should expect to settle for between 5 and 10 percent on a secured 2nd, and even less for a sold out junior.