There are times when refinancing makes sense and it may make a lot of sense when it’s determined that refinancing a first mortgage makes sense on its own but financing an outstanding second lien can make the decision even better. What are the differences between first, second and even third liens? What are they and what is the importance of lien position?
A first mortgage is the one used to fund the primary purchase. A couple sees a home listed for $350,000, puts 20% down and finances $280,000. This mortgage is the first one based upon age and recorded as such at the county recorder’s office. There may also be a second mortgage that can be taken out at the same time as the first or later on. When used simultaneously with a first mortgage to buy and finance a home, the second mortgage can be the amount that is the difference between the down payment and the first mortgage. If the couple decided to put only 10% down, they could take out two mortgages. One at $280,000 and another at $35,000 with a $35,000 down payment instead of $70,000. Such a structure is commonly referred to as an 80-10-10 and is a strategy used to have a lower down payment yet avoid private mortgage insurance.
It’s also common for someone to have just one first mortgage then later take out a second lien. Say someone decides for a remodel and takes out an equity loan to pay for the upgrades. Or, a second lien can be taken out for any purpose such as debt consolidation or student loans. Yet the second lien takes a subordinate position to the first. Should the first lien lender ever be forced to foreclose, the second lien holder must wait for the first mortgage to be paid off along with any other superior liens such as property taxes or delinquent income tax. After settlement costs, whatever is left over is then used to pay toward the second lien. If there aren’t enough funds for the second lien to be settled the only other solution for the second lien holder would be to file a suit or otherwise settle with the borrower. That’s why second liens carry higher rates due to the additional risk involved.
Now say a couple has a $280,000 first and a $35,000 second. They can reduce the rate on the first lien by nearly 1.50% saving quite a bit of money yet they can also refinance the second lien with the higher rate, eliminating it and having one new first lien with a lower overall monthly payment. Your lender can help structure such a transaction but an experienced loan officer will provide various scenarios where you can combine the two loans into one which could save you hundreds in interest payments. Later on, should you so decide, you can take out another second lien or home equity line of credit. It’s all up to you. But combining two mortgages into one is more common than you might think.
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