Retired foreclosure expert Ramsey Su has a theory that could render the meteoric rise in notices of default (NODs) to date slightly less alarming.

It all comes down to that local favorite: second-lien mortgages. More commonly known as piggyback loans, these mortgages allowed home purchasers to make smaller (if any) down payments and were thus in fairly widespread use in recent years.

The theory is that some homeowners are doubtless in default on both their primary mortgages and their piggybacks. Every such borrower might be served with two NODs — one for each mortgage. The number of NODs filed could thus be understating the number of homeowners in trouble as compared to what we saw in the early 1990s, when piggyback mortgages weren’t as ubiquitous.

On the other hand, Mr. Su believes that the NOD double counting may soon cease, if it hasn’t done so already. He writes:

In the beginning of the cycle, my guess is the NODs, and even NOTs [Notices of Trustee Sale], could be double counted. Junior lien holders initiated foreclosure proceedings while keeping current all senior delinquencies such as mortgage payments to the 1st, property tax, and insurance, hoping for recovery in the end.

I suspect the learning curve is quite steep, as junior lien holders realized they were suffering total losses. Junior lien servicers today are probably instructed to do some loss analysis before incurring foreclosure cost and investors are less likely to throw good money after bad.

By now, in other words, issuers of piggyback mortgages may have realized that there is little chance of recovering any losses and stopped bothering to initiate foreclosure proceedings. If this is the case, then the period of double counting has already come and gone.

Unfortunately, Mr. Su does not know of any way to confirm or deny any of this. Neither do I. But it’s worth keeping this potential distortion in mind as we track the number of defaults and foreclosures as an indicator of market distress.


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