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But in the situation we're talking about with the New Jersey law, we'd end up in a situation in which of the two mortgages on the property, only the first one is paid off (because the first bank is only incentivized to set an upset price that makes them whole, and the second bank isn't capable of outbidding the family because of the right of first refusal). I'm pretty sure the unpaid second mortgage can't follow the property, but it still wasn't paid.
In this situation, does the second mortgage just disintegrate, or does the bank holding the second mortgage have a way to pursue a judgment against the homeowner for the unpaid debt? If so, how does that interact with a subsequent bankruptcy by the homeowner, keeping in mind that the homeowner would have a house with no mortgages attached to it and thus probably be past the equity number for an exemption?
The New Jersey law would strip the second lien, but it wouldn't absolve the debtor of the requirement to pay the note. The creditor could sue the debtor for nonpayment and get a recorded judgment, which would allow them to garnish wages, levy bank accounts, and, yes, attach a judgment lien to the debtor's property. While it sounds like they get their mortgage back, this is more of a consolation prize, because in any foreclosure action they would be junior to any real mortgages, including ones that were recorded after the judgment lien. They would also be junior to any mechanic's liens. Effectively, they're now at the bottom of the list. If the debtor receives a bankruptcy discharge at any point in this process, it would eliminate their obligation to pay anything. The only exception would be if the creditor obtained a judgment and recorded a judgment lien against the property before the creditor filed. Then the lien would remain, though the personal obligation would be extinguished and they couldn't continue any other collection activities.
I apologize because it's only now that I'm wrapping my head around what you guys were talking about; before I was just trying to give some general background on how bankruptcies work. Suppose the house is worth $400,000. Mortgage 1 is $200,000 and Mortgage 2 is $100,000. Under the NJ law, Mortgagor 1 initiates a foreclosure action with an upset price of $200,000. Per the law, the owner exercises his right of first refusal and buys the house at the upset price, stripping Mortgage 2. Mortgagor 2 now has a note worth $100,000 but no security interest in the property. Mortgagor 2 then sues the owner for nonpayment of the note, but the owner files for Chapter 7 bankruptcy before judgment is entered, staying the suit. There are no other liens on the property at this point, and the owner's only debt is the $100,000 he owes to Mortgagor 2. After applying the exemption, the trustee has $336,850 available to distribute to unsecured creditors, which easily covers the $100,000 owed to Mortgagor 2. The property is sold for $400,000, $100,000 of which goes to Mortgagor 2, $100,000 goes to the trustee's commission, and $200,000 of which goes back to the owner. Maybe this counts as "abusing the system" in a strict technical sense, but like most such abuses, you'd have to be really stupid to think you're getting one over on anyone.
Awesome, this makes it a lot more clear to me. Thank you for providing your expertise on the topic!
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In theory, the bank could sue on the note just like a credit card company can sue you if you don't pay your credit card bills. In practice, those kinds of lawsuits usually don't accomplish much because most people don't have assets which can be seized. Which is why credit card companies usually end up settling for pennies on the dollar.
Let's suppose that the bank holding the second mortgage gets a judgment which then becomes a lien on the original property. I'm pretty sure that this is nowhere near as good as having a mortgage. For one thing, there may be a homestead exemption. For another, it's difficult or impossible to convince a sheriff to actually seize the property in that situation. Usually you will be told to just wait for the person to sell or otherwise transfer the property.
Does seem like you have to thread a pretty narrow needle to be able to afford the upset price of the house, but not to have an income stream that a judgment could seize.
Of course, the family part of this law makes it all more workable, because the person with no assets and the person buying the house can be two different people.
Well how about this scenario:
The first mortgage is has a balance of $300k; the second mortgage has a balance of $150k; the house would bring $400k at auction; the first mortgage is foreclosed and the upset price is set at $300k; the owner of the house goes out and gets financing from the Bank of Predatory Loans which gives him the $300k to buy the house plus $15k in "cash out." The owner buys the house, thus wiping out the second mortgage so that now he owns the house subject only to a $315k mortgage from the Bank of Predatory Loans, which mortgage quickly balloons to $400k and is then foreclosed, selling at auction for the same $400k.
The net effect of this is that $100,000 which should have gone to holder of the second mortgage instead goes $85,000 to the Bank of Predatory Loans and $15k to the original homeowner. Who gets kicked out anyway but at least he got to stay there another year and he got $15k for his trouble.
Or to put it another way, if a destitute person has the right to buy a piece of real estate at significantly below market value but lacks the money to do so, it seems almost certain that predatory lenders will show up to facilitate the transaction and appropriate to themselves the lion's share of the profits.
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