Can someone explain what a second mortgage is?

When you have a mortgage, a creditor has certain rights to your house – you have taken out a loan and pledged your house as collateral. That is, if you do not pay the money back as promised, then the lender has certain permissions to take and attempt to sell your house in order to pay themselves back. The “first” mortgage holder is the lender that is first in line to get that money, if forcing a sale is necessary. A “second” mortgage is a loan taken with either the same lender or a different lender who is willing to stand second in line to get paid in the case of default. Sometimes homebuyers take out 2 loans in order to buy a home with a smaller down payment, or to squeeze under conforming loan limits… other times, a homeowner takes “cash out” in the form of a second mortgage or an equity line of credit (which is also a mortgage, for these purposes) in order to improve the home, invest, send kids to college, etc. The number (first mortgage, secocnd mortgage, third mortgage) refers to the pecking order in the case of default – the order they get paid – NOT the chronological order in which the loans were obtained.

When a homeowner has a first and second mortgage, and then pays off the first, the second lender automatically moves into first position. Thus, when a homeowner wants to refinance the first loan and replace it with another first loan, he or she needs the second lender’s permission to do so – the second lender must agree to “subordinate” – to remain second in line, even though they should move up to first – so that a new first lender can cut in front of them in the payoff order. If permission is not granted, it is impossible to get a new “first” loan with the second still there.

Second mortgages often carry higher rates or more restrictive terms because of the increased risk. When a home is foreclosed, the value often plummets. The first lender will have to pay legal fees, back taxes, back insurance, etc. in addition to the debt itself … and often there is not enough leftover to pay the second lender in full. Thus, it is a riskier position for the lender. The less equity there is in the house (equity = the difference between the house’s value and the total amount of mortgage debt), the riskier the position is (and the more difficult it will be to get a second loan, or the higher the rate will be).