If the balances in the first and second loans cannot be paid off, both lenders typically have the right to sue the borrower for balances owed, plus interest and other costs. If both lenders sue the borrower and win, each will be granted a "deficiency judgment." Such a judgment will give both lenders the legal right to garnish the borrower's wages, seize his or her bank accounts, and place a levy against other property not exempted by state law. However, not all states allow deficiency judgments. In a state that does not allow for such a judgment, a lender's rights to proceed against a borrower are terminated once the property is foreclosed upon. Once the foreclosure is complete, the lender may not pursue further collection activity.
In addition to the above, when the first mortgage lender carries out a foreclosure sale, the second mortgage lender may also bid for the property at the time of foreclosure sale. Even after the property has been sold at auction, the second mortgage lender may pay off the required amount of money to the first mortgage holder and get the property back at the end of the "redemption" period. These last two options are attempts to recover the money the second mortgage holder has invested, although they are rarely undertaken (particularly in a weak housing market).
Additionally, a second lender can also charge-off any unpaid debt after getting a part of the sale proceeds when the first loan is paid off. This means, the second lender considers the debt uncollectible, but legally, the borrower still owes the money. Therefore, if the second mortgage holder charges-off the loan while it will no longer pursue a borrower, the second mortgage holder can still sell the right to collect on the debt to a third-party collector. The third-party collector has the legal right to make continued attempts to collect the debt.
In addition to dealing with collection action, the borrower will have to deal with several other issues that will affect their financial future. A charge-off will have a negative impact on the borrower's credit score. In addition, a charge-off may be considered income by the IRS. However, federal law does provide for relief, depending on the circumstances.