Seconds

Nomenclature

Mortgages encumber real property by making it security for the repayment of a debt.  A first mortgage is the first loan that’s secured by a particular piece of property.  Quite naturally, It follows that a second mortgage is a loan secured by the same property.  The third loan on the same property would be a third mortgage on the same property, and so forth.

Risk vs. Reward 

Statistically, people who have less of their own money in a property have a higher rate of default.  In the event of a foreclosure (non-payment), mortgages are paid off in order of their numerical priority.  Because of this, each successive loan on property is increasingly riskier for a lender.  Thus a second mortgage is in second position (or junior) to the holder of the first mortgage which means the second mortgage lender won’t see dollar one until the first mortgage lender has been paid in full.  Because seconds are inherently riskier, lenders demand higher interest rates, typically 1-5% higher than first mortgages.  Further, the higher the Combined Loan To Value (CLTV) of the first and second mortgage, the higher the rate one should expect to pay for the second.  Reason:  see the third sentence of this paragraph. 

Terms

Again, because they’re inherently riskier, they command a quicker pay off period, some as short as 3-10 years.  It is not uncommon to have 30 year 2nds, but a 30 year amortization with a balloon of 5-15 years is more common.   (A balloon loan is any mortgage that comes due with an unpaid balance is known as a balloon loan.  Most second mortgages are balloon loans.  Naturally, the final monthly installment that pays off a loan’s entire remaining principal balance is called a balloon payment).  The most common of these loans is known simply as a 30 due in 15 (commonly notated as 30/15).  The benefit to borrower is that the monthly payments are lower because the payments are based on a 30 year amortization schedule, even though the actual term of the loan is only 15 years. 

Amounts  

The loan amounts for seconds depends on the number of units and its designation which begs the following questions: is the property a single family residence (SFR), a duplex, a triplex, planned unit development (PUD) or a condo? Is it owner occupied (o/o) or non-owner occupied (n/o/o) [also known as investor property]?  Lenders will lend higher LTVs on first mortgages for S.F.R.s that are owner occupied as compared to other types of property, which in turn means, that seconds on these properties can be smaller and there is a larger number of lenders willing to write them.  But with an investor properties, the LTVs are more restrictive for firsts dropping from 80% down to 75%, 70%, and 65% which often necessitates second mortgages in the range of 20 to 35% and the sources for them are considerably fewer.  

Types   

There are two basic second mortgage types: Fixed Rate Mortgages (FRMs) and Adjustable Rate Mortgages (ARMs) a.k.a., variables.  Some second mortgages are fully amortized, like a 15/15 or a 25/25, i.e., a 25 year term due in 25 years.  As the name implies, a fixed rate mortgage is one in which the rate is fixed for the term of the loan and merits little more elaboration. 

The most common variable is the Home Equity Line of Credit (HELOC).  It is an open ended loan or revolving line of credit linked to the Prime Rate that allows the borrower to borrow against it repeatedly, pay it down and then borrow again, if so desired.  The benefit of a HELOC is that one only pays interest on the amount one draws down.  With the recent interest rate hikes HELOCs have become increasingly pricey of late (9/2006).  Most equity lines require monthly payments of 1.5% to 2% of the remaining principal balance.  If your credit is good enough there are lenders that will provide HELOCs as much as .3% below the Prime Rate (currently it is 8.25%).  Many institutional lenders will provide free HELOCs to borrowers through brokers, paying for both the closing costs and appraisal.   A prepay term is typically required to allow the lender sufficient time to recoup their out-of-pocket expenses. 

As second mortgages go, the rarity is the “silent” second. A silent second is a mortgage for owner occupieds wherein the mortgagor (the borrower) makes no mortgage payments, but when the owner sells the property they must pay off the new mortgage balance.  I say new mortgage balance because this is not an interest-free loan.  The mortgage is negatively amortizing such that the interest that one would normally pay monthly is deferred on the loan and added to the original loan balance to arrive at the newly accrued mortgage balance.  

These seconds are available only to a limited degree to low-income, first-time buyers and special occupations like teachers, policemen and firemen and often in amounts that exceed typical second mortgage LTV percentages.  They are provided almost exclusively through the auspices of FHA lenders and certain municipalities. 

Sources 

The lenders of second mortgages come from two sources:  conventional lending institutions such as banks, savings and loans, insurance companies, credit unions and non-conventional, like seller financing (private party).  In most situations the institutional lender that provides the financing for the 1st can also “piggyback” the 2nd with the 1st and usually provide the borrower with reduced underwriting fees and loan closing costs. 

Another source of seconds is Seller Financing.  It can facilitate a sale that would not otherwise happen, and benefit both the buyer and seller. With seller financing the seller will loan all (1st & 2nd) or a part of the sales price and take back a mortgage (usually a 2nd) on the property as security.  This means that the buyer can come to closing with less cash, and promise to pay a certain amount to the seller over time, with interest.  There are no lender fees, loan fees, or points charged for Seller Financing, so the buyer pays less in transaction costs.  With no underwriting or appraisal, the seller can attract buyers that would otherwise not necessarily qualify to purchase the property.  If the seller has made money on the property, under Seller Financing the seller may be able to defer the capital gains tax payable as the principal is repaid under the seller financed loan. 

With seconds inching into the range of 10-13%, a more cost effective alternative for LTVs between 80% and 90% that is becoming increasingly attractive to borrowers is the much maligned Private Mortgage Insurance (PMI). 

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