Second Mortgages – When To Write The Check To The Senior?
One of the truly perilous aspects of holding or enforcing mortgages is the jeopardy imposed upon a junior lender when a senior mortgage goes into default. While, to be sure, such are the vicissitudes for which junior lenders must be steeled in advance, the danger to the subordinate position is no less traumatic.
If default upon a first mortgage elicits a foreclosure action, the subordinate mortgagee obviously recognizes that its mortgage is subject to total extinguishment, and there is nothing more serious than that consequence. How to best protect the junior position? The answer is found in some basic legal and business decisions.
Most often, when a senior mortgage goes into default, there is also a default on the subordinate mortgage. (It does not have to happen that way but as a practical matter it typically does.) Although vigilant attention to defaults is always recommended, first mortgagees have the luxury of knowing that they are in a superior position and, save loss of title for tax defaults or precipitous physical deterioration of the property, not much can destroy their security.
That is not so, however, for the subordinate lender who is, to a significant extent, at the mercy of a first mortgagee. (That mortgagee might move slowly with its case.) Thus, when faced with a default upon a senior mortgage, the junior should give special consideration to instituting foreclosure faster than it might otherwise contemplate. The goal is for the junior to arrive at a foreclosure sale first, that is, before the senior. If achieved (and if there is equity in the property) someone should buy the property at the junior sale and the problem then evaporates sooner rather than later.
Even if the subordinate lender is unfocused in its approach to foreclosing, it should at least be sure to interpose a notice of appearance in the senior action. That adds not inconsiderable detainment to the first’s foreclosure while at the same time allowing the junior to track case progress.
Whether or not the junior lender can beat the senior to the courthouse steps, when to advance money to the senior is a decision which must be addressed. This then leads to the realm of business, rather than legal, decisions.
The last thing a lender desires to do is write a check to someone else, even to protect its position. (You may have to do it, but you cannot be expected to like it.) Do you have to write a check? If the senior gets to a foreclosure sale before you do, the answer is yes, unless you have no equity to protect or if buying at the senior will not create a surplus which comes back to you.
Putting aside here the strategy of bidding at a senior sale, lets concentrate upon advancing sums to a senior prior to its foreclosure. The exigent point to consider is the default rate of interest on the senior mortgage. As is generally understood, well drafted mortgages will provide for the applicable rate of interest when default ensues. It could be the note rate, or it could be higher, 12%, 14%, 18%, 24% or the “highest rate allowed by law.” Since usury does not have application to interest on default, there is no limit on what the rate could be, although as a practical matter few lenders would consider assessing more than 24% or 25%, the latter being the limit for criminal usury in New York.
If an advance is made to the senior, the junior can add that sum to its own debt together with whatever interest its own mortgage attaches to such advances. So, a key component in the ultimate analysis is whether it makes more sense to stop the accrual of interest on the senior now, adding the advance to your own junior debt, or allow interest due the senior to accrue.
An example should make the point. The first mortgage accrues interest at the default rate of 24%. Your junior mortgage assesses interest on advances at 14%. If you do nothing, interest on the senior which you eventually must pay, mounts at a precipitous rate. If the advance is made, that accrual is reduced by 10% – the difference between the senior’s default rate and your rate on advances. (This all presupposes, of course, that you will ultimately collect on your debt.) If your advance rate is greater than the senior’s default rate, the paying the senior could actually yield a profit.
In the end, its a combination of both a numbers game and measurement of how perilous it is for your department to write a large check. It is rarely an easy choice, but it is one which must be knowledgeably addressed.
Mr. Bergman, author of the four-volume treatise, Bergman on New York Mortgage Foreclosures, LexisNexis Matthew Bender (rev. 2017), is a partner with Berkman, Henoch, Peterson, Peddy & Fenchel, P.C. in Garden City, New York. He is also a member of the USFN, The American College of Real Estate Lawyers, The American College of Mortgage Attorneys, an adviser to the New York Times on foreclosure issues and writes a regular servicing column for the New York Law Journal. He is AV rated by Martindale-Hubbell, his biography appears in Who’s Who In American Law and he has been for years listed in Best Lawyers In America and New York Super Lawyers.