One Virginia attorney I’m trying to keep in mind is Kristi Cahoon Kelly, a consumer protection attorney whose office is in Northern Virginia. In 2014, I wrote a story about how she helped a Pittsylvania County homeowner, Carrie Arthur, fight a $130,000 mortgage foreclosure.
After her mortgage lender unlawfully ruined Arthur’s creditworthiness, Kelly sued the bank on Arthur’s behalf. This led to a secret agreement. And as a result, Arthur owed zero debt on her home loan. Instead, the bank erased it from property records as “satisfied” in a document it filed at the Pittsylvania courthouse.
Last week Kelly was back in the news. She was part of a team of attorneys that successfully settled a series of consumer fraud lawsuits against some payday lenders who unlawfully overcharged consumers. In all cases, the total settlements exceeded $1 billion.
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I emailed Kelly a quick congratulatory message. In response, she asked if I’d heard of “zombie second mortgages.” I had not. Wednesday during a phone call she informed me.
Obviously this is a burgeoning new area of consumer law. It stems from the housing bubble that preceded the 2008 financial crisis. And in the most egregious cases, this can result in homeowners being evicted from their home and losing all of their equity.
In the early 2000s, if you remember, house prices were skyrocketing and credit standards were lax. Some lenders made subprime loans without verifying borrowers’ incomes. Some people have managed to borrow money on behalf of their pets. Other mortgages contained only interest payments.
And certain borrowers took out two mortgages when buying a home instead of just one.
The first was a traditional mortgage, typically over 80% of the home’s value. With the second mortgage, buyers also borrowed their down payment—usually 20% of the sale price.
When home prices plummeted in 2008, many of these double-mortgage borrowers owed far more than their homes were worth — and were out of work during the Great Recession. Because of this, many stopped making payments on their second mortgages.
Meanwhile, many lenders, realizing there was no equity to raise through foreclosure, halted their collection efforts because it wasn’t worth their time or money. They wrote off these bad loans and in some cases sold the second mortgage debt to debt collectors for pennies on the dollar.
Now that house prices have risen again, suddenly there is equity in some of these houses with old unpaid second mortgages. And collection agencies are taking back those loans and trying to collect them.
That’s the nature of a “zombie second mortgage,” Kelly told me. It’s a home loan debt, often more than a decade old, for which collection efforts had long been thwarted, that suddenly comes back to life. And to which were added tens of thousands of dollars in late fees and arrears interest.
“They’re looking for people who are current on their first mortgage but defaulted on their second [mortgage]’ Kelly said. In cases where debt collectors can identify significant home equity, “they go back and add interest and late fees retrospectively.”
A decade’s worth of compound interest plus late fees can mean a severe financial shock.
In one instance, a Henrico client was told by Kelly that she owed $70,000 to a debt collector who had purchased a $33,000 second mortgage that the woman forfeited in 2011.
In a second case, a debt collector forced a disabled veteran’s second mortgage in Prince William County years after he paid off that debt through Chapter 7 bankruptcy.
After foreclosure on this second mortgage was complete, the debt collector paid off the first mortgage (on which the customer was currently). At this point the house belonged to the collectors. They sacked Kelly’s client and sold him to a third party. The debt collectors walked away with $200,000 in equity accumulated over the past few years, Kelly said.
“They bought a debt for pennies on the dollar,” Kelly told me. “Ten years later, they tried to collect the debt.”
Kelly is currently suing a California debt collector in federal court in the Eastern District of Virginia on behalf of these clients. It appears this could be escalated into a class action lawsuit.
She said that under federal law, it is illegal for collectors to retrospectively add interest and fees from prior years unless the original lender has periodically notified the debtor that those fees are increasing. But many borrowers do not understand this.
The same practice has occurred in at least 25 states other than Virginia, according to a federal complaints database I checked Tax office consumer protection.
How big is the problem in western and southwest Virginia? That is hard to say. But if it does happen in more populous parts of the Commonwealth, it seems only a matter of time before it shows up locally.
One of the local sources I checked with was Julie Wheeler, CEO of the Better Business Bureau of Western Virginia. She had never heard of “zombie second mortgages.”
“We get a lot of calls and help people file complaints about regular zombie debt,” Wheeler said. “Zombie credit card debt has been a big problem for a long time.”
Another local source was Roanoke County District Clerk Steve McGraw. He was also unfamiliar with the term. After taking care of it, McGraw called me back. He had a suggestion for consumers who had second mortgages years ago to let them forfeit.
McGraw stressed he cannot offer legal advice, but he can offer “procedural information” about deeds and mortgages filed in a local court.
For people in this situation, McGraw’s suggestion is simple: Before collection agencies get involved, contact the lender that last performed servicing on an expired second mortgage.
“Ask, ‘Are you going to or have you forgiven this debt?'” McGraw said. “If they do [file a lien release or certificate of satisfaction]you are protected.”
He added that no homeowner should be surprised if, years later, debt collectors suddenly contact them demanding payment on an old debt, even after a lender previously halted collection efforts.
“If [the borrower] doesn’t have a certificate of satisfaction…that commitment still sits there,” McGraw said. “I wouldn’t just let it levitate.”