What is First Mortgage?
A first mortgage also referred to as a primary mortgage or a senior lien, is a loan taken out by a borrower to purchase a property. When someone buys a home or other real estate, the first mortgage is the primary loan secured against the property. It takes precedence over any subsequent mortgages. In the event of default and foreclosure, the first mortgage holder has the primary claim on the property proceeds.
After understanding what the first mortgage is, let us know the features of the first mortgage.
- What is First Mortgage?
- Features of First Mortgage
- What is a Second Mortgage?
- Features of Second Mortgage
- First Mortgage vs Second Mortgage
- Example of First Mortgage
- Few Things to Note about First Mortgage and Second Mortgage
Features of First Mortgage
Key features of a first mortgage include:
- Priority: The first mortgage holds the highest priority lien on the property, granting the lender a first right to claim repayment in the event of foreclosure.
- Loan-to-Value (LTV) Ratio: The LTV ratio represents the percentage of the property’s value that the lender agrees to finance. In most cases, first mortgages allow borrowers to finance a substantial portion of the property’s value, often up to 80% or more.
- Interest Rates: First mortgages typically offer more favorable interest rates compared to subsequent mortgages due to the lower risk associated with being the primary lien holder.
- Repayment Term: The repayment term for first mortgages can vary, but they generally span from 15 to 30 years. Longer terms result in lower monthly payments but may accrue more interest over time.
What is a Second Mortgage?
A second mortgage, also known as a junior lien, is a loan taken out against a property that already has an existing first mortgage. Homeowners often opt for a second mortgage to access additional funds or consolidate debt. Unlike the first mortgage, a second mortgage is subordinate to the first lien and has a lower priority in the event of default or foreclosure.
Features of Second Mortgage
Key features of a second mortgage include:
- Subordination: Second mortgages are subordinate to the first mortgage, meaning that the first mortgage lender has priority over the proceeds in case of foreclosure. This increases the risk for the second mortgage lender, resulting in higher interest rates.
- Loan-to-Value (LTV) Ratio: Second mortgages typically have a lower LTV ratio compared to first mortgages. Lenders may offer up to 85% of the property’s value, considering the combined loan-to-value (CLTV) ratio of both the first and second mortgages.
- Interest Rates: Second mortgages generally have higher interest rates compared to first mortgages due to the increased risk faced by the lender. However, they tend to offer more favorable rates than other forms of unsecured loans.
- Repayment Term: The repayment term for second mortgages is often shorter than that of first mortgages, ranging from 5 to 20 years. Shorter terms allow homeowners to repay the loan faster but result in higher monthly payments.
First Mortgage vs Second Mortgage
Let’s delve deeper into the specific differences between a first mortgage and a second mortgage:
Priority and Lien Position
The primary distinction between a first mortgage and a second mortgage lies in their priority and lien position on the property. A first mortgage is the initial loan taken out to purchase a property and holds the highest priority lien. It takes precedence over any subsequent mortgages or liens on the property. In contrast, a second mortgage is a loan taken out against a property that already has an existing first mortgage. It is considered subordinate to the first mortgage and holds a lower priority in terms of repayment.
Loan-to-Value (LTV) Ratio
The loan-to-value ratio refers to the percentage of the property’s value that the lender is willing to finance. In the case of a first mortgage, borrowers can typically finance a substantial portion of the property’s value, often up to 80% or more. This means that the borrower can secure a loan for a significant amount of the property’s purchase price. On the other hand, second mortgages generally have a lower LTV ratio compared to first mortgages. Lenders may offer up to 85% of the combined loan-to-value (CLTV) ratio, considering both the first and second mortgages together.
Interest rates for first mortgages tend to be more favorable compared to second mortgages. This is primarily due to the lower risk associated with being the primary lien holder. First mortgages typically have lower interest rates, reflecting the priority and security enjoyed by the lender. Second mortgages, being subordinate to the first mortgage, present a higher risk to the lender. Consequently, interest rates for second mortgages are often higher than those for first mortgages. However, second mortgage rates may still be more favorable compared to other forms of unsecured loans.
Repayment terms for first mortgages and second mortgages also differ. First mortgages generally offer longer repayment terms, spanning from 15 to 30 years. The extended repayment period allows borrowers to make lower monthly payments. In contrast, second mortgages typically have shorter repayment terms, ranging from 5 to 20 years. Shorter terms result in higher monthly payments but enable homeowners to repay the loan faster.
Example of First Mortgage
Let us say you purchase a property worth $300,000. You pay $80,000 and finance the remaining amount of $220,000 by way of the first mortgage. After a few years, you take another loan of $50,000 for repairs and improvements through the second mortgage. Now, you face financial crises and are unable to repay the loan. Hence, the lender is compelled to foreclose on the mortgage by selling the property. The property fetches only $250,000. In such a scenario, the first priority to claim against the property proceeds is of the first mortgage holder. Therefore, he will receive $220,000, and after he is fully satisfied, the remaining proceeds of $30,000 are paid to the second mortgage holder. The second mortgage holder will not receive the full claim, as the sale of the property did not bring enough proceeds to pay both lenders in full.
Few Things to Note about First Mortgage and Second Mortgage
The first mortgage holder does not get the ownership of the property; he only gets the lien on the same. The borrower is free to do whatever he wishes to do with the property but generally cannot transfer it without obtaining prior consent from the lender.
The borrower does not usually need the first mortgage lender’s consent for obtaining the secondary mortgage. However, the secondary mortgage lender will always want an assurance that the borrower has enough equity in the property. So that their interest is protected in case of non-repayment or default.
In recent times, the first mortgage has gained popularity due to its benefits. The lenders feel secure about the money they lend to the borrowers.
- Senior Debt Vs Junior Debt: Introduction, Differences and More
- Pledge vs Hypothecation vs Lien vs Mortgage vs Assignment
- Senior Debt – Features, Importance, Advantages And More
- Subordinated Debt – Meaning, Example, Risk, and More
- Mortgage Underwriters: Meaning, Useful Factors, Outcomes and More
- Intercreditor Agreement – Importance, Provisions And Issues