One Virginia attorney I’m trying to keep tabs on is Kristi Cahoon Kelly, a consumer protection attorney based in Northern Virginia. In 2014, I wrote a story about how she helped a Pittsylvania County landlord, Carrie Arthur, fight a foreclosure on a $130,000 mortgage.
After his mortgage lender illegally trashed Arthur’s credit rating, Kelly sued the bank on Arthur’s behalf. This resulted in an undisclosed settlement. And as a result, Arthur ended up owing zero on his home loan. Instead, the bank erased him from real estate records as “satisfied” in a document he filed in the Pittsylvania courthouse.
Last week, Kelly made headlines again. She was part of a team of attorneys who successfully concluded a series of consumer fraud lawsuits against certain payday lenders who illegally overcharged consumers’ interests. In all cases, total settlements exceeded $1 billion.
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I sent Kelly a brief note of congratulations. In response, she asked me if I had heard of “zombie second mortgages”. I did not have. Wednesday during a phone call she informed me.
Apparently, this is a new and growing area of consumer law. It stems from the housing bubble that preceded the 2008 financial crisis. And in the most severe cases, it can lead to homeowners being evicted from their homes and losing all the equity in them.
In the early 2000s, if you recall, house prices were skyrocketing and lending regulations were loose. Some lenders have issued subprime loans without verifying borrowers’ income. Some people have had success borrowing money on behalf of their pets. Other mortgages had only interest payments.
And some borrowers have taken out two mortgages on the purchase of a home, rather than one.
The first was a traditional mortgage, typically representing 80% of the home’s value. With the second mortgage, buyers also borrowed their down payment, usually 20% of the sale price.
When house prices crashed in 2008, many of these mortgage borrowers found themselves owing far more than the value of their homes — and out of a job during the Great Recession. Because of this, many have stopped payments on their second mortgages.
Meanwhile, many lenders, realizing there was no equity to seize via foreclosure, ceased their collection efforts as it was not worth their time or money. They wrote off those bad debts and, in some cases, sold the second mortgage debts for pennies on the dollar to debt collectors.
Now that house prices are on the rise again, there is sudden equity in some of these homes with old unpaid second mortgages. And debt collection companies resuscitate these loans and try to collect them.
That’s the nature of a “zombie second mortgage,” Kelly told me. It’s a home loan, often more than a decade old, for which collection efforts had long since expired, that is suddenly brought back to life. And to which were added tens of thousands of dollars in late fees and retroactive interest.
“They’re looking for people who are current on their first mortgage, but have defaulted on their second. [mortgage]”, Kelly said. In cases where debt collectors can identify substantial equity in the property, “they go back and add interest and late fees retroactively.”
A decade of compound interest plus late fees can be a brutal financial shock.
In one case, a client Henrico of Kelly learned she owed $70,000 to a debt collector who had purchased a second mortgage for $33,000 that the woman had let expire in 2011. She had forgotten about it years later. early, after his lender suspended efforts to collect the debt.
In a second case, a debt collection company foreclosed on a disabled veteran’s second mortgage in Prince William County – years after he had paid off that debt through Chapter 7 bankruptcy.
Once the foreclosure of this second mortgage was completed, the debt collector paid off the first mortgage (on which the client was outstanding). At that time, collectors owned the house. They evicted Kelly’s client and sold him to a third party. The debt collectors walked away with $200,000 in equity that had accrued over the intervening years, Kelly said.
“They bought debt for pennies on the dollar,” Kelly told me. “Ten years later they tried to collect the debt.”
On behalf of these clients, Kelly is currently suing a California debt collector in federal court in the Eastern District of Virginia. It looks like this could be expanded to a class action lawsuit.
She said that under federal law, it is illegal for collectors to retroactively add interest and fees from previous years, if the original lender had not regularly notified the debtor that those fees were mounting. But many borrowers don’t understand this.
This same practice has occurred in at least 25 states other than Virginia, according to a database of complaints I reviewed at the federal Consumer Protection Bureau.
How big is the problem in West and Southwest Virginia? It’s hard to say. But if it happens in more populated 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 hadn’t heard of “zombie second mortgages.”
“We get a lot of calls and help people file regular zombie debt complaints,” Wheeler told me. “Zombie credit card debt has been a major problem for a long time.”
Another local source was Roanoke County Circuit Court Clerk Steve McGraw. He didn’t know the term either. After looking into the matter, McGraw called me back. He had a suggestion for consumers who have second mortgages years ago that they let expire.
McGraw stressed that he could not offer any legal advice, but could offer “procedural information” about deeds and mortgages filed at a local courthouse.
For people in this situation, McGraw’s suggestion is simple: Contact the lending institution that last serviced an expired second mortgage — before debt collectors get involved.
“Ask, ‘Do you want or have you discharged this debt?'” McGraw said. “If they do [file a lien release or certificate of satisfaction]you are protected.
He added that no landlord should be surprised if debt collectors suddenly contact them years later to get payments on an old debt, even after a lender had previously ceased collection efforts.
“Whether [the borrower] doesn’t have a certificate of satisfaction…that obligation is still there,” McGraw said. “I wouldn’t just let it float.”