People often have more than one mortgage on their home. For instance, a second mortgage might have helped cover the cost of the initial purchase, or, you could have taken out a home equity loan for a kitchen remodel, college costs, or a vacation. If you fall behind on your payments, you’ll likely face a foreclosure. Which mortgage holder initiates it—the first or the second—will depend on your home’s value.
Understanding Mortgage Documents
When you take out a loan to purchase a home, you’ll have to sign two important documents: a promissory note and a mortgage (or deed of trust in some states.) The promissory note is the document in which you promise to pay back the loan. The mortgage gives the lender a security interest in the property.
It’s the mortgage that provides the bank the right to foreclose if you default on (fail to pay) the monthly note payment. It will have a clause that makes clear that the home will be used as collateral to ensure that you repay the loan. (For additional information, read Understanding Foreclosure: Your Loan and Foreclosure Documents Hold the Answers.)
Second Mortgages: Lining Up for Payment
The term “second mortgage” means that if you don’t make your mortgage payments on either the first or second loan, and the first-mortgage holder forecloses to repay the amount you owe, the second-mortgage holder gets paid after the first mortgage gets its share. This concept is called “priority.”
How Priority Works
The mortgage priority determines which obligation gets paid first after a foreclosure sale. This “first come, first served” system depends on the date the mortgage records in the office of the county recorder. The mortgage in the first position gets paid in its entirety. If anything is left over, the next mortgage in line—often called a “second”—will get paid out of the balance. Sometimes the remaining funds are enough to take care of the second mortgage, but it’s common that the funds fall short.
Example. Let’s say Josh bought a home and took out a $300,000 loan. A few years later, he took out a $20,000 home equity loan. After suffering an illness, Josh fell behind on his mortgage payments and the first lender foreclosed. The home sold at a foreclosure sale for $320,000. In this scenario, both the first and second lender will be fully paid. But if the foreclosure sale only brought in $300,000, the first lender would be satisfied while the second lender would not only get nothing, but would lose its security interest in the home, as well. Additionally, Josh would likely remain on the hook for the $20,000 deficiency amount (depending on his state's laws).
How the Second Lender Gets Paid
If the foreclosure doesn’t bring in sufficient funds to fully repay the second, the bank in the second position has limited options. Because the home is no longer available to sell, the second lender will probably file a lawsuit (unless state law prohibits it) in an action called a “suit on the promissory note.” The note you signed when you took out the loan gives the bank this right. Once it gets a court judgment, you’ll have to repay the amount you still owe—$20,000 in the example above. (For more helpful information, see When Should I Hire a Foreclosure Attorney?)
When You Pay the First But Not the Second
If you default on your first mortgage, it is very likely that the first lender will foreclose. On the other hand, if you stop making payments on the second, you might—or might not—face a foreclosure. The current value of your home will be the predominate factor the bank will assess when determining whether to foreclose. Why? The bank in the second position must fully repay the loan in the first spot before receiving a penny.
When You Have Equity
If the market value of your home is more than what you owe the first lender, your second lender is likely to consider moving forward with a foreclosure. The reason is that the second stands to recover some or all of the money it loaned you after the first lender gets paid. The more equity you have in the home, the more likely it is that the second bank will foreclose.
When You Don’t Have Equity
If you owe more to your mortgage lenders than what your home is worth, you have “negative equity.” (This is also known as being “underwater” or “upside-down” on the home.) Under these circumstances, even if the second lender foreclosed, the price at the foreclosure sale probably wouldn’t be sufficient to pay off that debt. So, if you're upside down and stop paying your second mortgage, that lender is unlikely to foreclose because it wouldn’t get anything out of the sale. However, it could still sue you to get repaid. (To learn more, see What Happens if You Default on a Second Mortgage?)
Questions for Your Attorney
- I can’t keep up with both my first and second mortgage payments. Should I pay off the second mortgage if I can come up with enough money?
- Can I eliminate my second mortgage by filing for bankruptcy?
- What can I do to stop the second lender from foreclosing?