Why Zombie second mortgages are threatening thousands of Americans' homes

LEILA FADEL, HOST:

Zombie mortgages - second mortgages that many homeowners thought were long gone - are putting thousands of Americans at risk of losing their homes. Chris Arnold from our investigations team and Robert Smith with Planet Money have more.

CHRIS ARNOLD, BYLINE: One spring morning a couple of years ago, Karen MacDonough was having tea in her little two-bedroom house in Quincy, Mass.

ROBERT SMITH, BYLINE: She looks out the window and sees something unusual.

KAREN MACDONOUGH: There were, like, 20 cars and they all came at the same time, and they parked, like, in front of my house, across the street, up the street.

SMITH: A bunch of men get out, and Karen sees them walk up onto her lawn. So she goes out to see what's going on.

MACDONOUGH: There was somebody, I think he might have had a uniform on or something, and he had a piece of paper and I said, what's happening? And he goes, we're selling your house. I'm like, what are you talking about? And he's like, well, we sent you information. And it was, like, a foreclosure sale on my home.

ARNOLD: This made no sense. Karen had been in the house for 17 years. She raised two kids there, and she was current on her mortgage.

SMITH: Sure, she had been getting mysterious phone calls about some old debt. She thought it was a scam or something, but what was happening now seemed very real.

MACDONOUGH: I was, like, shaken. Just, like, really overwhelmed.

ARNOLD: Those strangers on her lawn ended up selling her house out from under her.

MACDONOUGH: Just didn't make any sense. I'm a mother and I'm a nurse, and I'm being evicted from my house that I've been making monthly payments on, and that I'm current with.

SMITH: Karen had fallen victim to what's called a zombie second mortgage. They're called zombies. Homeowners think they're dead, but then they come back to life because they get bought up sometimes for pennies on the dollar by some debt collector.

ARNOLD: And an NPR investigation reveals that this is happening to a lot of people. We filed freedom of information requests across several states and found more than 10,000 people who've recently gotten foreclosure notices over what appear to be old zombie second mortgages.

SMITH: So here's what's been happening. Back during the housing bubble days, a lot of people got not one, but two mortgages on their house.

ARNOLD: Then the financial crisis hit and millions of Americans were losing their homes to foreclosure, so many that the government pushed banks to do what are called loan modifications to lower people's interest rates.

SMITH: Karen MacDonough got her first loan modified, and she and many other people say as part of that, the mortgage company told them that their smaller second mortgage was going away, being forgiven.

MACDONOUGH: I was actually in my kitchen, I was cooking dinner and I was talking to a representative, and he told me I would never have to make a payment again on the second mortgage. And I just didn't question any of it 'cause I was so grateful that the loan was modified.

ARNOLD: She used to get two bills in the mail. After a while, she only got one. She thought that second loan was dead.

SMITH: But behind the scenes, investors have been buying up those old, defunct mortgages. The owner of Karen's didn't agree to an interview, but we found someone else to explain the business.

DAVID GORDON: My name is David Gordon. I run a company called ARC Private Equity.

ARNOLD: David buys up old loans, and he says often people think that the loans were canceled. But in many cases, he says...

GORDON: They still exist. It's not like they went away. And I think people were waiting on the sidelines to collect on those at some point.

SMITH: They were waiting because if you foreclose on a house, the first mortgage gets paid back first and any money left over goes to the second mortgage.

ARNOLD: So back after the housing crash, homes weren't worth enough to even pay back the first mortgage if you foreclosed.

SMITH: But home prices are up. That's more money for the debt collectors to go after. If they foreclose now and sell the house, there's enough money to pay back both mortgages.

GORDON: I'm not looking to take anybody's home. I want to make that clear.

ARNOLD: David says he tries to work with homeowners and he follows the rules. But if a homeowner doesn't pay or doesn't respond, he does foreclose.

GORDON: Nothing is free in this world. And if you signed up for a loan, you know what you signed up for. It blows my - it just, you know, it is what it is.

SMITH: You know what you signed up for, sure. But in Karen's case, she believed that what she had signed up for had changed, that the second mortgage was forgiven.

ARNOLD: And the company calling her to collect was asking for more than two times what she had originally borrowed. They wanted $184,000.

SMITH: Lately, lawyers across the country have been getting panicked calls from people like Karen. Kristi Kelly's not Karen's lawyer, but she runs a consumer law firm in Fairfax, Va.

KRISTI KELLY: It is not right. You should not lose your home.

ARNOLD: Kristi says the record-keeping on these old loans, it was really bad.

KELLY: There's no database of, like, all the loans that are canceled or forgiven so you can go and verify it.

SMITH: But Kristi says she's found a way to fight back against the debt collectors. Kind of like a crossbow for fighting the zombies. She says many of these debt collectors add on a huge amount of retroactive interest and fees.

ARNOLD: Federal law, though, requires that to charge interest, the homeowner, over time, has to be getting monthly statements. And in many cases, Kristi says, that just never happened. Nobody got any statements for, like, 10 or 12 years.

SMITH: So Kristi can say in court, these guys are breaking the rules and asking for way too much.

KELLY: In some ways, the greed of these second mortgage holders has given people leverage in their cases because they want to go and get every last dollar and take every dime of equity, they then open themselves up to serious legal consequences.

SMITH: Kristi has used this strategy to help hundreds of homeowners over the past couple of years.

ARNOLD: Still, she's just one lawyer and knows that there must be thousands more out there who need help.

SMITH: Among them, Karen MacDonough, back in Quincy, Mass. Although she lost her house to foreclosure, she got a judge to stop her eviction.

MACDONOUGH: I feel like what happened was a terrible thing, but I'm still, like, really hopeful I'm going to win this case.

ARNOLD: Karen's lawyers are arguing in a lawsuit that the second mortgage really was forgiven, or it should have been, and that the people who foreclosed on her, the company's called First American National, that they have not followed the rules. The company denies this.

SMITH: Until a judge rules, Karen is staying put. She's even planting flowers outside.

MACDONOUGH: Yeah (laughter).

SMITH: But you don't technically own this house anymore.

MACDONOUGH: It's still my house. Like, it's on principle.

SMITH: You're still mowing the lawn?

MACDONOUGH: Yeah. It's still my home.

SMITH: I'm Robert Smith.

ARNOLD: And I'm Chris Arnold, NPR News.

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