The Disadvantages of Having a Standalone Second Mortgage
A first mortgage is simply the first loan or installment paid on a residential piece of property. If the property is financed through a mortgage broker, the broker maintains the first mortgage. The first mortgage holder has the first legal right or lien on the property if the borrower defaults. Most often, first mortgage lenders are financial institutions such as banks, credit unions or mortgage bankers. There are other private first mortgage lenders.
First mortgage lenders are usually the largest financial institution with the best mortgage loan programs and credit terms. When a first mortgage holder takes over a property from a previous owner, there are usually subordinate agreements in place. These may be a variety of documents known as subordination agreements, warranty deed agreements, or first liens. In some instances these agreements allow the first mortgage holder to sell the property outright and take the money they need. In other instances the first mortgage holder and the second mortgage holder will create an instrument known as a master promissory note.
Each loan has its own due date, and the due date varies between different loans. The first mortgage lien holder must pay off the first mortgage before taking possession of the property. At this point the second mortgage holder may not have priority over the first mortgage holder. The priority is determined by the current position of the loans.
As the housing market has fluctuated over the past decade, it is likely that many borrowers have either lost their primary residence or it could only be with them temporarily. This means that many borrowers are behind on their payments and are going through a property looking to refinance, sell, rent out or move to a new home. One of the options for them is to apply for a home equity loan. A home equity loan or a standalone second mortgage allows the borrower to use their equity to pay their existing loans. In many cases a homeowner can have the second mortgage paid off faster than their first mortgage.
The second mortgage lien holder will receive the funds from the home equity loan much faster than the first mortgage holder. In some cases the second mortgage holder will be able to sell the property on their own within a short period of time. In other cases the second mortgage holder will be forced to sell the property by the owner going into default on their first mortgage. In these instances the borrower will receive the funds from the sale of the house quickly.
In many cases a borrower will take out a second mortgage to pay off their first mortgage, but they will sometimes forget or intentionally leave out important details. They may not realize that they have omitted important terms on their original first mortgage contract. For example, many first mortgage holders require a borrower to make monthly payments based upon their income. This could include overtime pay, commissions and other such payments.
For those that are in the process of selling their homes, they may inadvertently include such terms as “periodic payments,” which essentially means that the loan has an ongoing payment once the house has been sold. While this may sound great for the buyer, it is actually a huge disadvantage for the seller as well. As mentioned earlier, first mortgages often carry higher financing costs than second mortgages so sellers will often receive only half the loan amount that their first mortgage holder received.
As you can see there are several disadvantages to standalone second mortgages. If you are in the process of refinancing your first mortgage, you should avoid this option as much as possible. If you must go with a second mortgage, make sure that you understand all of the terms and the implications clearly.