Lenders and borrowers continually enter into Loan Modification Agreements (hereinafter “Modification”) in order to resolve the pending foreclosure and put the parties back in good standing. This Modification usually works in the form of a single instrument, as opposed to a gap mortgage and consolidation agreement whereby the arrears are somehow capitalized in order to bring the borrower into a more affordable payment plan, or by extending the terms of the mortgage. A larger concern comes out of this resolution. Will the capitalization of the arrears impact the lender’s lien position? A case recently dealt with this query.

In Home Loan Inv. Bank v. Padilha, 2021 NY Slip Op 32222(U) (New York County Supreme Court 2021), counsel for the subordinate mortgagee argued that when the plaintiff (1st mortgage holder) modified the sums and capitalized said amount, the subordinate mortgagee’s lien position was in fact prejudiced. The court relied on case law which recited that when a senior lienor enters into an agreement which would prejudice the rights of a junior lienor, consent is required. While the Modification did lower the interest rate, it increased the principal by $81,228.46 and said increase did jeopardize the lien position of the subordinate mortgagee. Furthermore, the subordinate mortgagee did not issue consent to same. As a result, the court ruled that the sums added in said Modification were subordinated to the lien of the subordinate mortgagee creating a “sandwich” for priority. The amounts prior to the Modification for the senior lender remain in a 1st lien position, the lien of the subordinate mortgage would be next in line and the amounts capitalized on the senior mortgage would be in a 3rd lien position.

Counsel for the plaintiff attempted to rely on RPL §291 for priority purposes. The court felt that this was inapplicable as said section makes no reference to subsequent agreements. Most impactful was the language in the statute that the “terms of the mortgage shall retain priority of the original mortgage lien as so increased provided that any such mortgage instrument set forth its terms of repayment”. The mortgage being foreclosed contained no such language. The court further went on to state that even if that section was applicable, it only references “unpaid interest” and no other sums.

In most Modifications, the amounts added are not merely unpaid interest. In my opinion, if principal is not increased and the arrears due are deferred without paying interest on said sums in the form of a balloon payment or forgiven, the prejudice argument would fail. Having said that, once the amounts are increased over the existing principal at the time of the Modification, the subordinate lender will be prejudiced.

With the potential increase of Modifications based on the impact of the Foreclosure Abuse Prevention Act, we suggest running an updated search prior to the issuance of said Agreement to ensure the lender’s lien position is protected. Depending on the facts, the lender may need to enter into a Subordination Agreement with the subordinate lender.

As always, we are here to assist with any questions or concerns.

Please contact David Schwartzberg, Foreclosure Counsel, at
dschwartzberg@advantagegroupny.com or 631.549.7721 with any questions.