If you own an underwater home, should you continue to pay on your second mortgage? Lots of people stop paying, and they don't worry about it. Why don't they worry about it, you may ask? Because the second mortgage holder probably has zero equity. Nada. No security for that loan. If there is nothing securing that loan, the mortgage lender is unlikely to file for foreclosure because there is no financial gain to do so.
When a second mortgage lender files for foreclosure, to perfect it, the lender needs to make up the back payments to the first lender, if any, and take over the first loan after foreclosure. Lenders will do this if there is equity; however, if the first mortgage is underwater, too, who wants the house? Not the second, that's a given.
Let's say you paid $500,000 for that home in Elk Grove, California. You financed it through an 80 / 20 combo loan, which was so popular in 2005 and has pretty much vanished today from the face of the Earth. So, you took out a $400,000 first mortgage and a $100,000 second mortgage. Today, that home might be worth $225,000, if you're lucky. Go over to Zillow and check the value of your home.
If you short sale the home, you get rid of $500,000 worth of debt, give or take, and, relying on your real estate agent for information, you may wrongly assume the bank will release you. After all, these are purchase money loans that carry no recourse in the event of foreclosure, as any California real estate lawyer will tell you. However, you may not realize that foreclosure and short sale are two different animals.
When you do a short sale, lenders retain certain rights and, depending on the verbiage in the short sale approval letter, a lender could retain the right to go after you. That's right, in California, banks have 4 years to pursue a deficiency judgment after agreeing to a short sale -- if you didn't get released at the time.
That's why you should always get legal and tax advice before pursuing a short sale. And choose your Sacramento short sale agent with care. Agents can't give legal advice, but hopefully your short sale agent obtained a release of liability for you and directed you to a lawyer who could explain your legal obligations. There are a lot of agents hanging out that short sale shingle in Sacramento, so you've got to be careful. We are not all the same.
In closing, don't take this piece of information as carte blanche to stop making mortgage payments on your second mortgage, as I am not advocating anything -- get legal advice. People who stop making their mortgage payments could lose their homes. I'm just sayin'.