What are First and Second Mortgages ?
What is a First Mortgage?
When most people purchase a home or property, they take out a home loan from a lending institution that uses the property as collateral. This home loan is called a mortgage, or more specifically, a first mortgage.
This can be formally defined as a primary lien (a legal claim against assets that are used as collateral to satisfy a debt) on a property that secures the mortgage in case of default or non-repayment of the loan. In case of default by the borrower, the lender can sell the property in order to recover the amount along with the interest, and has priority over all other liens or claims.
What is a Second Mortgage?
A second mortgage, also called a home equity loan - is money borrowed against home equity for refinancing purposes or to fund other projects and expenditures. The second mortgage and any other subsequent mortgages taken out on the same property are subordinate to the first mortgage and are made while an original mortgage (first mortgage) is still in effect. This means the first mortgage must be fully paid off in order for the secondary mortgage to receive payments in the event of default. As a result, the interest rate charged on the second mortgage tends to be higher and the amount borrowed will be lower compared to the first mortgage.
Example of First and Second Mortgages
Let us say, you purchase a home with a $300,000 mortgage. This is your first mortgage on the property. Over the next few years, you pay down your mortgage. You now owe $210,000 on the first mortgage. You also want to do some remodeling, so you take out a home equity loan for $20,000. This is a second mortgage.
If you decide to stop making your house payments, your first mortgage lender would force a sale of the house to recoup their $210,000 before the second lender is entitled to try to get back their $20,000.
Extra things to note about First and Second Mortgages
The first mortgage holder does not obtain ownership over the property.
The borrower does not usually need the first mortgage lender's consent for obtaining the secondary mortgage. However, it is required for the borrower to have enough equity in the property so that, in case of default or non-repayment, the interest of the second mortgage lender will be protected.