Wouldn’t it be wonderful if there were no such thing as personal fiscal responsibility? We could all adopt the U.S. government’s approach to the national deficit. We could simply ignore our personal debt — with impunity. There would be no need to worry about our car payments, student loans, credit card debt — or even our mortgages. We could just keep on spending — with impunity.
Alas, that seems unlikely. So while the government continues to spend money it doesn’t have — with impunity — the rest of us must pay our bills, or face the consequences. We all know what will happen if we don’t pay our utility bills, or miss a few car payments. We also know what happens if we miss a few mortgage payments. But what happens if someone doesn’t pay their second mortgage? Keep reading to find out.
The consequences of second mortgage defaults
By definition, a second mortgage is a secured loan that a homeowner obtains by using their house as collateral. These typically include but are not limited to home equity loans or home equity lines of credit.
Second mortgage defaults occur when homeowners fail to make required payments on said loans. The consequences vary based on how much your home is worth and how much you still owe on your primary mortgage.
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If your home is worth more than the remaining amount on your first mortgage, you have equity in your home. This means that your second mortgage is still somewhat secured. This also means the second-mortgage holder will probably pursue foreclosure to recoup some or all of its money.
On the other hand, if you owe more on your first mortgage than your home is worth, your second mortgage is no longer secured.If the second-mortgage holder pursued foreclosure in this case, it would be less likely to recoup its money. This is because the second mortgage is usually classified as the junior mortgage.
As the superior mortgage holder, the first-mortgage holder would have first dibs on the proceeds from the foreclosure sale. But this is not the only hurdle that second-mortgage holders face.
Barriers to second mortgage foreclosures
Fortunately for distressed homeowners, second mortgage foreclosures don’t happen all that often. That’s because there are additional barriers to second mortgage foreclosures. In general:
- Secondary lien holders are barred from foreclosing on your property if your second mortgage is current.
- Primary and secondary lien holders are barred from foreclosing on your property if superior mortgage and junior mortgage are current.
- If your first mortgage is current but your second mortgage is not, the secondary lien holder is not barred from foreclosing on your property.
So as you can see, there are limited rights of second lien holders in foreclosure.
Clarifying liens and lien priority
To clarify, a lien is a legal claim against a property. In this context, the term lien priority is used to describe the order in which lien holders are paid after foreclosure.
More often than not, lien priority is date-based. Specifically, priority is usually assigned based on when the mortgage was officially recorded. So let’s say someone got a mortgage which was recorded on January 10, 2020. Now let’s assume the same person obtained another mortgage, which was recorded on October 28, 2020. The former would be designated as a first mortgage, and receive first-lien position. The latter would be designated as a second mortgage, and given second-lien priority.
Having said that, homeowners should be aware that some liens, such as property tax lines, are viewed as superior to any prior liens. In most, but not all cases, judgment liens are junior to a first mortgage. They may also be junior to a second mortgage, and to other judgment liens depending on the order in which they were filed.
How does refinancing your first mortgage affect the priority assigned to your second mortgage?
As if all of that isn’t confusing enough, things get even more complicated if you refinance your first mortgage — or get a cema loan if you live in New York. In this case, the first mortgage holder will mandate that the second-mortgage holder enters into a subordination agreement. In this type of agreement, the second-mortgage holder agrees to make its loan junior to the refinanced loan. In other words, the refinanced loan, which is technically the newest loan, gets first priority through the subordination agreement.
A second-mortgage holder can sue you to recover the amount owed
To reiterate, there are limited rights of a second lien holder in foreclosure. This is because foreclosure on the first mortgage triggers foreclosure on any junior loans including a second mortgage, home equity loan, or home equity line of credit. This domino effect also results in the loss of security interest in the property. The end result is that the secondary lien holder effectively becomes a “sold-out junior lienholder.”
However, this does not mean a second-mortgage holder cannot recoup its money. Laws vary from state to state, but in most cases, a secondary lien holder can sue you for the amount owed. You give the lender the right to pursue this option when you sign a document promising to repay the loan and then fail to do so.
Assuming the second-mortgage holder wins a judgment for the amount owed, there are several ways it can collect:
- It can have a specified amount of money withheld from your paycheck each pay period until the debt is paid.
- It can have a specified amount of money taken out of your bank account for a specified period until the debt is paid.
- It can use any other “regular” collection methods as warranted.
If you are struggling to pay your first or second mortgage, consider speaking with a qualified legal or financial professional about your options. Depending on your situation, filing for bankruptcy may be one way to reduce or eliminate your financial liability.
If you don’t have a second mortgage yet, but you are considering getting one to finance other large purchases, it may be worth considering other options. Specifically, you may want to consider options with similar rates that don’t require you use your home as collateral. That way your home won’t necessarily be at risk in the long run.