Currently loan modifications are one of the most common loss mitigation workouts used to bring a loan current. However, one important question has yet to be addressed in many states: ‘Absent a future advances clause or consent of the junior lien holders, does a modification of a first lien alter the priority rights between the first lien holder and any junior lien holders?’
A recent adversarial bankruptcy proceeding in IN RE WHITE, No. 12-47895-CEC (Bankr. E.D.N.Y. Aug. 14, 2014) provided some insight into this issue. The action, filed by second mortgage holder, sought to subordinate all or a portion of the first mortgage because the first mortgage holder had provided a HAMP modification to the debtor. The court discussed two situations where the modification of a senior lien can cost the senior lien holder its priority, (1) modifications that prejudice “the rights of the junior lien holder or impairs its security” and (2) modifications which may “prejudice the rights of the junior lien holder, but do not substantially impair their security interest or destroy their equity.” If the former occurs courts have held that the junior lien holder can completely subordinate the first lien and is entitled to first position. If the later occurs, courts have held that “the senior lien holder will be required to relinquish to the junior holder its priority with respect to the modified terms only.” The court held that the modification by the first lien holder (creating a deferred principal balance and lowering the interest rate) did not prejudice the junior lien holder.
While a mortgage may be modified for numerous reasons the two most common terms that when modified will prejudice a junior lien holder are increasing the amount secured and raising the interest rate. By altering a senior mortgage in those two ways a senior lien holder can lose some or all of its priority. In contrast, most courts have found that modification of payment schedules will not prejudice junior lien holders except in cases where the priority of lien holders was established by a subordination agreement. See C. & S. NAT’L BANK OF SC v. Smith, 284 S.E.2d 770, 277 S.C. 162 (1981).