First or Second Mortgage?

The borrower is required to make payments on both the first and a second mortgage. It is even possible to have a third or forth mortgage.

However, the first mortgage, which becomes the first mortgage by being recorded at the county recorders office first, has priority in the event of mortgage foreclosure.

In fact, if the first mortgage holder (lender or mortgagee) commences a foreclosure action they will have their attorneys do a title search. They will discover who else has a legal interest in the property. They will foreclose the interest of any second mortgage holders.

What does this mean in plain English?

Assume the property is worth $100,000. There is a first mortgage of $80,000 and a second mortgage of $10,000.

You own the second mortgage. The borrower stops making payments on the first mortgage (or deed of trust). And the lender forecloses the loan. By the time this loan goes through the legal system, the first mortgage balance could now be $90,000 and the house is probably not in great shape. The house is sold by the court (or trustee depending on the state).

You have the right to bid at the sale and pay off the first mortgage and keep the property. But would you want to? And someone else can bid on the property and if they bid enough, you will be next in line to get paid what is left after the first mortgage is paid off. (Up to the balance of what you are owed). But it’s not likely to happen.

Another possibility is that you could keep the first mortgage current and foreclose your second mortgage. Most lenders will agree to this, but they may not be forced. to do this. Read the Legal Ruling on this subject.

So the chances are that you will get wiped out.

Does this mean you should never make or own a Second Mortgage?

Maybe. But commercial lenders do make second mortgage loans. PROVIDED the borrower has good credit.

Also you can reduce your risk if the Combined Loan to Value (CLTV) ratio is lower. For example. Say the property is still worth $100,000 but the first mortgage is only for $70,000. The second mortgage is for $10,000. The CLTV is now 80%. ($70,000 first mortgage plus the $10,000  second mortgage divided by the property value $100,000).

Interest rates on second mortgages typically are 2-4% higher than first mortgages.

Some people will take the extra risk and hope that the good ones will pay for the few bad ones where they will get wiped out. Others won’t. It’s your choice.

We recommend that if you do originate a second mortgage it should be for at least 50% of the value of the property. Let me explain what this means:

Scenario 1. House is worth $130,000 and it sells for $100,000. Buyer puts down $10,000. Buyer borrows $40,000 from the bank. You lend second mortgage for $50,000.

Scenario 2. House is worth $130,000 and sells for $100,000. Buyer puts down $10,000. Buyer borrows $80,000 from the bank. You lend second mortgage of $10,000.

Scenario 1 is safer for you than scenario 2. If the buyer defaults, it is easier for you to make payments on a $40,000 first mortgage than an $80,000 first mortgage.

Plus why go to all that hassle just to create a mortgage that pays you about $140 a month?