When planning to buy a house, potential homeowners usually borrow money from lenders. If you plan to do this anytime soon, it would be helpful to learn about the different types of mortgage you can get. That way, you might understand their good points and bad points. This article will tell you how the first mortgage and second mortgage work, when you need them, and how they differ from each other.
How the First Mortgage Works
Any mortgage that you apply for the first time with the purpose of acquiring a property is considered your first mortgage. Automatically, it also is also your first lien mortgage.
For example, Richard wants to purchase a house worth $500,000. The only money he manages to save over the years is $160,000. To make the house his property, he needs to apply for a loan and get the remaining money.
That makes the money he borrowed worth $340,000 in total with the property as collateral. His first-ever mortgage is also his first-lien mortgage.
However, Richard may decide to improve his house. With still a remaining loan to pay, he decides to apply for another loan from another lender to renovate. He wants to fix the front yard and add a pool, so he borrowed another $80,000. This second loan is obviously his second mortgage. When he borrowed for the second time, he again listed the property as his collateral for the loan.
In case something happened, and Richard was not able to pay his loans, the house would be at risk. That is how collateral works. Since his house is the collateral to his loans, it could end up foreclosing if Richard is not able to meet the agreed payment terms.
If Richard did fail to pay his dues, who gets the house and its profits? Here is how it would work and how the magic of the first lien would take over.
What Is a First Lien?
A first lien is the first in line to be fully repaid in case of the borrower’s inability to pay their debts. Automatically, the second lien is the second in line. Once the first debt or first lien gets paid, only then can a second-lien enjoy what remains.
Richard’s house is then sold at $550,000. Since Richard still owes the first lender a remaining $150,000, the first lien lender would automatically have a claim on his collateral. Since there is still remaining money, the second lien could also recover the $80,000 he borrowed.
Should the house get sold at a lesser value than what it should be, then the first lien would still get the first payment. The only catch is that they might only receive a portion. The second lien might not get any payment at all.
When to Get First and Second Mortgage
People get loans for various reasons. A mortgage specifically is for a purchase of a property or anything related to property. Borrowers usually use the first mortgage to pay the house, but the second loan could be used for other purposes.
Whether you plan to conduct renovations or pay for your child’s college education, vacation, and other purposes, you are free to do so. Most homeowners use the second mortgage to renovate the existing house or pay for closing costs. The second mortgage usually has a higher interest rate due to its higher risk.
Mortgages come in many different forms and have a lot of complex terminologies. Instead of becoming overwhelmed by these overflowing differences, you only need to sit down and learn how it works—including the difference between a first and second mortgage.
Should you need a mortgage lender for your home buying concerns, we can help. ACB Mortgage Solutions provide the tools, knowledge, and expertise for you to find the best financing solution there is. Schedule an appointment with us, and we will help you find the quickest and most efficient loan there is.