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80/20 Hindsight

QUESTION:

A good friend got one of those “low doc” or “no-doc” mortgages in Nevada in 2006 – one of those 80/20 “deals.” The 20-percent part was foreclosed, and the house was sold. However the 80-percent portion is still outstanding. What can they do about the first loan?

ANSWER:

Your good friend hit a jackpot of sorts. Let’s see what happened.

Someone bought a property in Nevada in 2006, at or near the top of the market. To finance the purchase ¬– say, $200,000 – he got a $160,000 first lien and a $40,000 second lien. The property was purchased with no money down, with a “piggyback” mortgage and something less than a fully documented loan application.

The first lender, the one with 80-percent financing, probably thought they had little risk because the property could sell for 20-percent off, and they could still break even – or something close. The second lender can only be explained if it felt the market was absolutely going to rise.

Oh well.

Both lenders have the right to foreclose for nonpayment or other violations of a loan agreement. Why the second lender would foreclose is unclear. In a foreclosure all money from the property sale goes to the first lender. Only when the first loan is entirely paid off is any remaining cash paid to the second lender. Given what has happened to home values in Nevada in the past five years, it’s difficult to imagine that the second lender got a dime.

Here’s the problem: Will one or both lenders now sue the borrower to get back their cash? Your friend needs to have a talk with a Nevada attorney regarding foreclosures, deficiency judgments and taxes. Why taxes? Because if the property was an investment, the unpaid mortgage balance may be regarded as taxable income.

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