The default rates on first and second mortgages went up in September from August per S&P/Experian Consumer Credit Default Indices. Still, the first mortgage default rate was one basis point lower from a year ago.
This talk about first and second mortgages makes one wonder: what is a first mortgage and what is a second mortgage? What’s the difference and will knowing it help when shopping for mortgages?
It certainly does and it helps to shop and compare mortgage rates too. Click here.
Of First and Second Mortgages
The “first” and “second” in mortgages basically denotes the repayment priority of these loans and exists for different purposes.
First-lien mortgages provide all or a substantial portion of the funds needed to buy a home. They are the first to be paid off when the property gets sold off or refinanced.
Second mortgages, on the other hand, help borrowers avoid paying private mortgage insurance. For example, you take out a primary loan to finance 80% of the purchase price and then get another loan to cover the 20% down payment. This is applicable to conventional loans.
This second loan will assume the second-lien position and will be subordinate to the first-lien mortgage in terms of repayment. Because it has to wait for the primary mortgage to be repaid, the second mortgage carries a higher rate.
There are silent second mortgages, however, that are offered as a form of down payment assistance. Does your lender know of one? Talk to a lender today.
Second Mortgages Before and After the Purchase
Taking out two loans at once when you purchase a property can be challenging because (a) you pay two separate set of closing costs and fees and (b) you make two mortgage payments thereafter.
Thus, some opt to take second mortgages sometime after the purchase. These second mortgages borrow against the equity in the home. Assuming the home has significant equity, you might receive 80% of the home’s value minus the outstanding loan balance.
These second mortgages called home equity loans are useful for homeowners looking for additional cash for so many things, debt consolidation, home improvements, education costs, planned major expenses, etc.
- Line of credit: This is what you get when you apply for a home equity line of credit, or HELOC. Like a credit card, you can draw money and make minimum payments at a variable rate. Once this draw period of between 5 and 10 years is over, the repayment period takes place for the next 20 years. During this period, you have to make the full principal + interest payment until such time as the loan gets repaid.
- Lump sum: You’ll receive this at closing when you opt for a home equity loan or HEL. This is a fixed-rate loan and calls for equal payments every month. Interest rates on home equity loans can be lower because they are deemed safer (they attached to the property). Qualification can be less stringent even for people with bad credit.
Both first and second home loans complement each other. Whether you take out a second mortgage before and after the purchase, weigh the costs of getting one versus its perceived benefits.
Remember, you’ll be making two separate monthly payments on your first and second mortgages unless you can refinance to combine them.
If down payment is your concern, you can look into low to no down payment loans. These are available with the VA, USDA, or FHA and can be combined with down payment grants and loans.