Zombie Mortgages Could Force Some Homeowners Into Foreclosure

Homeowners around the country are facing large bills and even foreclosure threats from investors who own their second mortgages. The loans were often made more than a decade ago. High home prices have given the investors a new incentive to try to collect.

Many homeowners say they were unaware that their second mortgages still existed. Lenders often “charged off" these loans years ago, deeming them unlikely to be repaid after borrowers fell behind. Many homeowners stopped receiving monthly statements, giving them the impression that the mortgages had gone away.

They hadn’t. The lenders sold the second mortgages to other investors, sometimes for just pennies on the dollar. Now, some borrowers could lose their homes even though they have been consistently paying the bills they receive each month for their primary mortgages. Federal regulators have taken notice.

Investors both large and small are part of the ecosystem that makes mortgage lending work in the U.S. Some investors say their goal is to positively impact homeowners’ lives by helping them resolve past debt. They also say that borrowers are obligated to pay what they owe.

Warren A. Brown was flummoxed when he got a notice last fall telling him that the Randallstown, Md., home he lives in was subject to foreclosure. The reason, he learned: failure to make payments on a home equity line of credit taken out in 2006.

Brown hadn’t known the second loan existed, he said. He moved into the house and started paying the primary mortgage in 2010. His brother, an architect who designed and owned the house, died in 2015, and the house is now owned by his estate.

“I had been paying a mortgage for 13 years," Brown said, “and so I didn’t understand it at all."

The owner of the second loan is FirstKey Master Funding 2021-A Collateral Trust, according to an affidavit from a lawyer who filed foreclosure paperwork against the estate in February.

The affidavit said the estate owed about $180,000. Almost half of that was interest, the affidavit said, charged at a rate of 6.625% for more than 14 years.

FirstKey Mortgage is owned by private-equity firm Cerberus Capital Management. A spokesman for Cerberus declined to comment.

Second mortgages, including home equity lines of credit, were popular in the boom years leading up to the global mortgage meltdown.

Investors have owned and traded them for years. But their investments got a lot more valuable when housing prices shot up over the past several years.

In a foreclosure, the second-mortgage holder is paid only if the home still has equity left after the first mortgage is paid off. Higher home prices mean that, increasingly, the second-mortgage holders can be made whole.

“All of a sudden we saw these second mortgages come out from under the woodwork," said Andrea Bopp Stark, a senior attorney at the National Consumer Law Center. “It’s a moneymaking opportunity."

Nonperforming second mortgages sold for 59% of the unpaid principal balance in 2022, versus 40% in 2021, according to data from Paperstac, a small platform where individual investors trade these notes.

Luz and Orlando Mora bought a four-bedroom house in Lithia, Fla., in 2006. They got both a first mortgage and a smaller, second mortgage.

Around 2014, they got a mortgage modification. Their first and second mortgages were from the same lender, and they thought the second mortgage was included in the modification. They stopped getting statements on the second mortgage years ago, Luz Mora said.

In 2021, the Moras received a letter from a mortgage servicer, Specialized Loan Servicing, that said their second mortgage was in default.In March 2022, the mortgage’s owner, Gulf Harbour Investments, filed a foreclosure lawsuit in state court in Florida’s Hillsborough County.

SLS said in an affidavit filed in September 2022 that the Moras owed more than $100,000 on their second mortgage, which had an initial value of $57,200 in 2006.

“I am really scared to lose my home," Luz Mora said.

“Foreclosure is always a last resort and is only undertaken where all other reasonable attempts to resolve the position have failed," SLS said in a statement.

Gulf Harbour couldn’t be reached for comment.

Some 1.84% of active second mortgages originated between 2005 and 2008 are late on payments by 90 days or more. The delinquency rate on all second loans is less than half that, according to mortgage data and technology company Black Knight.

The Consumer Financial Protection Bureau held a hearing on these second mortgages in April. The agency released guidance telling certain debt collectors that they can’t threaten judicial actions, such as foreclosures, for debts that are past a state’s statute of limitations.

“The CFPB is hearing increasing reports of debt collectors seeking to resurrect these expired second mortgages," CFPB Director Rohit Chopra said at the hearing, where he referred to them as “zombie mortgages."

The affected homeowners are typically up-to-date with payments on their primary mortgages, and they have often accrued significant equity in a home they have owned for years, said Rick Alembik, an attorney in Georgia who has worked on dozens of these cases. The investors sometimes offer only minimal documentation to prove their calculations for how much homeowners owe in interest and fees, Alembik said.

Harston Jones received a letter from a law firm in mid-2020 threatening to foreclose on his Atlanta home. The letter said he hadn’t been making payments on a home equity line of credit. He turned around and sued the investor, IslandCap, in Superior Court of DeKalb County, saying it hadn’t shown proof that it has the right to foreclose.

Jones had taken out the debt in 2006, but he thought it had gone away about a decade earlier, he said. After he lost his job and missed payments during the 2008 financial crisis, his lender told him that it had charged off the loan, he said.

Unbeknown to him, IslandCap had taken hold of the debt. The entity is associated with Paul Birkett, according to public records. His LinkedIn profile says he runs a $200 million investment fund.

“IslandCap buys defaulted mortgage loans at a discount from banks around the country," Birkett said in a statement. “It uses that discount to offer a deal to the borrower: simply restart your loan payments and IslandCap will take no further action. In the vast majority of cases, the borrower takes the deal."

Courts have sided against Jones’s lawsuit. Alembik, who is Jones’s attorney, said that state law as it is currently interpreted doesn’t offer substantial protection for homeowners against these investors.Jones is considering his other legal options.