NEW YORK (TheStreet) -- As banks are getting down in the trenches to help borrowers take mortgage debt down a notch, second liens are increasingly becoming a first priority.
Banks have begun to make long-awaited progress in resolving distressed primary mortgages -- even if it requires a principal cut, a short sale or an outright foreclosure. But non-primary loans have hindered progress as the industry continues to work through hundreds of billions of dollars' worth of first-mortgages that have fallen behind.
A healthy portion of the $10.7 trillion in outstanding U.S. mortgage debt is made up of non-primary loans. There are no federal data to indicate the breakdown of primary vs. junior mortgages. But using the four largest mortgage servicers as a proxy, 61% of their outstanding residential debt is tied up in non-primary loans.
There are home-equity lines of credit that were extended when home values soared past the initial purchase price. There are also so-called "piggyback" mortgages - secondary, tertiary and even quaternary loans - that lenders extended to those who wanted to buy during the boom but lacked cash for down payments.
Banks had been kicking the can down the road for second liens, trying to make headway on first liens first. But the issue is now front and center for a simple reason: If a borrower can't afford to pay the first mortgage, there's no reason to think he will be able to pay other types of home-loan debt any better.
"The second-lien holders are going to be taking massive losses," says Greg Hebner, who provides loss-mitigation services for large mortgage companies as president of MOS Group.
Hebner explains that second-lien holders have little recourse for handling troubled borrowers other than taking "big haircuts" on principal. Even though some second-lien holders can pursue foreclosure, they won't get any money until the first mortgage is made whole. Home-equity lenders have even less recourse, since the debt is comparable to a credit-card line: Secured only by notional home values that have wasted away.