What Happens to a Second Mortgage on a Short Sale of a Home?

A second mortgage increases the time and hassle of completing a short sale. A large portion of borrowers facing foreclosure in 2012 had more than one mortgage on their home, Bloomberg reports. A short sale involves a property that is worth less than it can fetch on the market. Lien holder permission is necessary in a short sale because the lien holder takes a loss. Second mortgage loans take the biggest hit in a short sale.

In a short sale, the seller must request approval of the sale from the first mortgage lender, also known as the primary lien holder and the second mortgage lender, known as a junior lien holder. As the main decision-maker in a short sale, the primary lien holder sets the sale parameters, such as price, closing costs and the closing deadline. Although junior lien holder participation in a short sale is voluntary, declining to cooperate usually results in foreclosure and a total loss for the second lender.

Second mortgage loans may be owned or serviced by the same company that handles the primary mortgage. Whether both loans are held by the same lender or not, the short sale approval process is handled individually for each loan. As such, negotiating a short sale with a second mortgage entails twice the effort. The seller submits two separate short sale requests and hardship packages according to each lien holder's specifications. Each lien holder may have distinct criteria for determining short-sale eligibility. Both must review and approve the seller's financial situation and the sales contract to provide stamps of approval.

A junior lien holder can derail a short sale deal. Money is the main point of contention for second lenders when rejecting short sales. First mortgage lenders usually offer several thousand dollar to the second lender to persuade it to release the lien on the home and allow the deal to happen. As of 2013, secondary lenders commonly hold out on granting approval in an effort to get more money out of the first lender. The second lender may not receive funds from any other interested party to the transaction, including the seller, buyer or agents. Difficult negotiations between first and second lien holders can delay short sale approval. The process typically takes two months when one lender is involved and four months or more when two are involved, according to Realtor.org.

A second mortgage lender may require you to sign a promissory note in which you promise to repay all or a portion of the loan amount in exchange for its cooperation in a short sale. If the lender accepts a relatively small sum at closing and forgives the debt, you may be liable for cancellation-of-debt taxes on the amount forgiven following your short sale. To avoid the debt-cancellation income tax, the second loan must have been obtained to "buy, build or substantially improve your principal residence," Inman News reports.