LA veteran completely blindsided by ‘zombie mortgage’ after 14 years. Why so many Americans are facing the same nasty surprise decades on

Murphy had stumbled into what’s known as a zombie mortgage, a long-dormant home loan that resurfaces years later, and, like many others who make such a discovery, didn’t realize it until he was in a tough spot trying to refinance or sell.

Even worse is that the debt has grown substantially in the years it lay dormant: Murphy’s initial debt was for $75,000, but now he’s being pursued for more than twice that — $159,355 — due to years of back interest (1).

Here’s what you need to know about these reanimated loans and how to figure out if you’ve got one lurking in the background.

Zombie mortgages trace back to the 2008 housing crisis

Zombie mortgages are typically a second home loan that dates back to before the 2008 financial crisis, and were also known as “piggyback mortgages” (2). These loans appeared to die during the housing crash, only to resurface years later, often when a homeowner tries to refinance or sell.

In the years leading up to the 2008 housing crash, a second mortgage was a means of allowing borrowers without adequate down payments to qualify for a mortgage without having to pay for mortgage insurance. A would-be homeowner who had only saved 10% of the purchase price could get a primary mortgage for 80% of the purchase price and a second mortgage for the remaining 10%.

Some borrowers took out an 80/20 mortgage — a primary mortgage covering 80% of the home’s value and a second loan covering the rest. This structure allowed buyers to finance a home with little or no money upfront.

Such easy loans made for risky mortgages, and when interest rates started to rise, defaults and foreclosures increased dramatically and the subprime mortgage bubble burst. The crash in property prices that followed made the “piggyback mortgages” close to worthless, and many were sold for a fraction of their face value. Housing prices have rebounded in the years since, turning these loans into a valuable asset to the debt collectors who bought them.

As for borrowers, many had their mortgages modified under the Home Affordable Modification Program (HAMP) or similar programs and thought that covered the second mortgage too. With no notices or statements arriving in the mail for years, they continued to think that the loan was modified, discharged in bankruptcy, or forgiven.

Not all of these loans have resurfaced as zombie mortgages. Some were written off or extinguished during foreclosures or bankruptcies, while others were quietly sold to investors who waited years to collect until rising home values made them worth pursuing again.

According to Bloomberg’s analysis of public property records, 5.5 million of these mortgages were made from 2002 through 2008 and an estimated 600,000 of these “piggyback mortgages” remain today (1).

How banks and regulators kept zombie mortgages alive

So, why do second mortgages have such staying power when so many primary mortgages didn’t?

Second mortgages were a “complication” to modifications undertaken in the wake of the mortgage crisis, according to The Financial Crisis Inquiry Report: “If a first mortgage is modified or foreclosed on, the entire value of the second mortgage may be wiped out” (3). And the country’s biggest banks had substantial amounts of capital tied up in those second liens.

According to a Congressional Oversight Panel Report from April 2010, four banks (Bank of America, Citigroup, JPMorgan Chase and Wells Fargo) had substantial portfolios of these second liens: as of the third quarter of 2009, a collective $442.1 billion. “At the end of that same quarter,” says the same report, “these four banks’ total equity capital was $459.1 billion” (4).

The report goes on to say, “There is a tension between Treasury’s goal of removing second liens as an obstacle to mortgage restructurings and Treasury’s stated interest in maintaining bank capital levels” (4). In other words, providing second-mortgage borrowers with relief might have required another round of bank bail-outs, so Congress prioritized the banks.