Some second-mortgage holders are demanding that distressed borrowers giving up their homes through short sales pay off their junior liens — under the table.

Nancy West, a marketing and outreach specialist in Santa Ana, Calif., with the Department of Housing and Urban Development (HUD), said HUD recently conducted a "sting" operation in which a second-lien holder had demanded that $5,000 be paid "outside the close."

Since such a payment would not be disclosed on the HUD-1 settlement form, the first-lien holder — which was taking a hit by allowing the short sale — would not know the holder of the second lien was getting a payoff, West said at a conference in San Francisco last week.

"On short sales, junior lienholders are asking for money and for it to be kept off the HUD-1," she said.

In a short sale, the home is sold for less than the amount owed on the mortgage and the lender accepts a discounted payoff. Normally when a home is sold through a foreclosure or short sale, second-lien holders are not supposed to get paid anything unless and until the first-lien holder is paid off in full.

The government's Home Affordable Foreclosure Alternatives program, which provides incentive payments for lenders to allow short sales, requires that payment by a borrower for a complete release of any subordinate liens be capped at $6,000.

But many holders of second liens are demanding payments larger than $6,000, in the form of cash to release the lien and allow a short sale to take place, West said

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.