Mortgage Tip: Sometimes It's Smarter Not to Pay, Even If You Can Afford the Debt
Pssst -- here's a quick personal finance tip for financially troubled people who have a first mortgage plus a home equity loan. If you can't make the payments on the first debt, don't pay the second one, either -- even if you can afford to. Payments on the second lien are money down the drain.
That seems so obvious that I wouldn't have thought to write about it until I talked with Guy Cecala, President and CEO of Inside Mortgage Finance Publications. He tells me that many people in mortgage default -- including one of his relatives -- keep up with their home-equity loans.
Why would they do that? A strong sense of decency, I'd guess. They've lost part of their income and can't pay everything they owe. But they want to make good on every debt they can. They cover the smaller and most essential payments first -- the auto loan or lease, so they can drive to work, and the credit cards, to be sure that they can buy groceries and gas.
If there's not enough left over to make their first mortgage payments, there might be enough to cover the home-equity debt. They pay it out of duty, because it's owed. That's morally, but not financially, sound. If they're in default and likely to lose their house, the home-equity payments are pure loss.
What's more, those payments might hinder their escape from debt. Say, for example, that they line up a short sale, where the holder of the first mortgage agrees to settle the loan for less than what's owed. The holder of the second mortgage (the home equity debt) can block the deal, to avoid being wiped out. If the second debt is obviously worthless, the lender will probably let it go. But if you've been making payments, the lender will block the short sale. The loan looks good and the lender won't want to let it go. By being so reliable, you lose your chance to break free from a debt that's choking you. Foreclosure or bankruptcy might become your only options.
What did Cecala advise his relative to do? "Forget the second mortgage, save your money," he said in a flash. The home-equity lender will survive and you'll have a better shot at getting a fresh start. Among debtors, there's such a thing as being too good.
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