Paying prior mortgage arrears: Risks versus Rewards
As legal counsel to mortgage lenders, we are frequently asked by second or third mortgage lenders whether they should pay the arrears on a prior mortgage that is in default. Fundamentally, this is a business decision, not a legal one, but there are several factors that a mortgage lender should consider when making this decision. There are a number of advantages to paying prior arrears, but, in some cases, also disadvantages.
Reasons to pay prior mortgage arrears:
1. Keep control. Paying prior arrears and keeping the prior mortgage(s) in good standing keeps the prior mortgage in good standing so that the lender has no reason to take legal proceedings. This keeps the lower-priority lender in the drivers’ seat when it comes to foreclosure proceedings.
2. Avoid extra legal fees. If a prior lender remains in default, that lender will likely start legal action. The prior lender will start accumulating legal fees that are payable under its mortgage, therefore, having priority over the subsequent mortgage(s). This eats away at the equity for the subsequent mortgagee(s).
3. Earn additional interest. Most modern mortgages will contain a provision permitting a lower-priority lender to add any amounts that the lender pays to keep a higher-priority in good standing, into its mortgage balance. This means charging interest on those payments at your second-mortgage rate.
Reasons not to pay prior mortgage arrears:
1. Go along for the ride. If a higher priority mortgage is in default, a lower-priority lender may not have to do anything at all, but could simply wait for another lender to take foreclosure proceedings, and then “ride along” with that foreclosure and wait for the property to sell. Although this approach saves spending on legal fees and the payments to the prior lender, it has significant risk; a higher-priority lender who is well secured is not necessarily motivated to move a foreclosure quickly, and the court may order a long redemption period that puts lower-priority lenders who have not started their own legal proceedings at risk.
2. Throwing good money after bad. In Alberta’s volatile real estate market, sometimes the value of a property has depreciated since the mortgage was advanced, to the point that the property can no longer be sold for enough money to pay out all the mortgages on title (especially after realtor commissions and legal fees are factored in). It may not be wise to inject more cash into a loan that is already facing a shortfall. A second lender should always keep the equity situation in mind when making this decision. The services of professional appraisers and realtors may be used to assist in determining equity.
The decision on whether to pay prior mortgage arrears is not a purely legal decision, but a question of business strategy. We hope these factors assist in the decision making, and our lawyers are always available for consultation.