Taking out a second mortgage can be an effective way to tap your home’s equity. In some cases, second mortgages can even be used strategically when purchasing a home. According to the most recent Census data, approximately 10.7% of homeowners have a second mortgage on their primary residence.
However, despite their subordinate position, defaulting on a second mortgage can have serious consequences, including damage to credit, financial judgments, and even foreclosure.
If you’re behind on payments, you’re not alone. Many second mortgage lenders prefer negotiation over foreclosure. There may still be options available.
- Defaulting on a second mortgage will harm your credit and open you up to financial judgments and the foreclosure of your home.
- Second mortgage holders will typically only pursue foreclosure if there’s enough value in your home to satisfy your first-position loan and have proceeds remaining.
- Options for avoiding a second mortgage foreclosure include asking for temporary forbearance, refinancing your loan, or negotiating a lump-sum settlement.
What It Means to Default on a Second Mortgage
Late on your second mortgage payment? You may not be at immediate risk, but getting caught up as soon as possible is essential.
Most lenders allow a 15-day grace period after your mortgage due date. If you pay within this window, you typically won’t incur any penalties. After the grace period, your mortgage is considered delinquent, and you’ll likely be charged a late fee, generally around 5% of your payment amount.
When your second mortgage payment is 30 days late, your lender will report it to the credit bureaus as delinquent, and it will begin to impact your credit score.
When Foreclosure Is a Possibility
At the 90-day mark, the lender will send you a notice of default letting you know you’re in breach of your mortgage agreement and that foreclosure is possible if you don’t bring your loan current.
After 120 days, federal law permits your lender to initiate foreclosure proceedings. However, with a second mortgage, this doesn’t always work the same way as a primary home loan.
Since a second-position lender doesn’t get paid until your primary loan is satisfied, they’re unlikely to pursue foreclosure unless the value of your home is high enough for them to recoup their funds.
Instead, if your state allows it, second-mortgage holders may choose to sue you directly and seek a court-ordered judgment for their losses.
Can a Second Mortgage Default Before the First?
Yes. A second mortgage can go into default even if you’re current on your primary mortgage payments.
That’s because lien priority and foreclosure orders are not the same thing. Even though a second mortgage is subordinate to the first lien, the second mortgage lender still has the legal right to initiate foreclosure proceedings independently of the primary lender.
Why a Second Mortgage Lender Would Foreclose First
Generally speaking, a second mortgage lender will typically only foreclose first when there’s sufficient value in your home to satisfy your primary loan and leave suitable proceeds for the second lender to collect.
You may also see a second mortgage lender foreclose in a declining market, even if they aren’t able to recoup the full loan balance. That’s because in this scenario, if they wait, your home’s value may shrink to the point where they cannot recover any funds at all.
Similarly, since the foreclosure process can take quite a while – especially in judicial foreclosure states – a second mortgage lender may foreclose first if home values are appreciating and they anticipate that suitable funds will be available by the time your property reaches the foreclosure sale.
When a Second Mortgage Is Not Likely to Foreclose
If your primary mortgage represents a considerable portion of your home’s value or if declining property values have left you underwater on your loan, a second mortgage lender is not very likely to foreclose.
According to the Federal Reserve Bank of Cleveland, foreclosed properties typically sold for about 27% below the market value of comparable non-foreclosed homes during the last housing crisis. Because of this discounted price, a second-position lender is unlikely to initiate foreclosure unless you have substantial built-up equity.
In this situation, they’re more likely to file a lawsuit based on your promissory note and attempt to recover their funds through the courts if at all possible.
2nd Mortgage Foreclosure: What Happens to the Homeowner
If your second mortgage lender chooses to foreclose on your home, the process is similar to a foreclosure on your primary loan.
Depending on your state’s laws, this could be through judicial foreclosure, where the lender files a petition and brings the case before a judge, or non-judicial foreclosure, where the lender follows established procedures to proceed without court approval.
If your property is foreclosed on and sold, you may have a redemption period where you can repay the total amount owed – plus fees – and recover ownership of your home. However, this option and timeframe for doing so can vary significantly by state.
Keep in mind that when a second mortgage lender initiates the foreclosure process, you’re still responsible for your primary loan.
While it’s unlikely that a second-position mortgage holder will foreclose unless the expected proceeds are more than enough to satisfy your primary loan, the first-position lender could still seek restitution if they don’t recover what they’re owed in full.
What If the Lender Doesn’t Foreclose? Lawsuits & Deficiency Judgments
If you default on a second mortgage and the lender chooses not to foreclose, they could sue you for a deficiency judgment that covers the losses they incurred on your loan.
Not all states allow deficiency judgments on primary residences, though, so the level of risk can vary depending on the applicable laws. In states with strong non-recourse protections, lenders can recover their funds only by selling the secured collateral.
If your state does allow deficiency judgments and your lender’s lawsuit is successful, you could be forced to pay through:
- Wage garnishment
- Levies on liquid assets, such as bank and investment accounts
- Liens on other properties you own
In some cases, lenders with a successful judgment may wait to enforce their claim until your finances improve in the future.
However, there is typically a statute of limitations for both filing and collecting on a deficiency judgment, and these time limits also vary by state.
Credit, Financial, and Tax Consequences of Defaulting
Apart from the potential for foreclosure and financial judgments, what else happens when you default on a second mortgage?
Late payments, especially foreclosures, significantly harm your credit. If your lender forecloses on your home, you can expect your score to drop by at least 100 points. In some cases, you may even see a drop of 200 points or more.
These negative marks can stay on your credit report for up to seven years and affect your ability to borrow in the future.
This is particularly true if you plan to purchase another home, as lenders impose waiting periods after a foreclosure, ranging anywhere from two to seven years, depending on the type of mortgage you apply for.
Potential Tax Liabilities
Another issue you may face is tax liabilities on any canceled or forgiven debt. IRS guidelines treat written-off mortgages as ordinary taxable income, meaning you could incur a sizable tax bill.
There are, however, exceptions for borrowers who are insolvent at the time of default. If you’re concerned about how defaulting on your second mortgage could impact your tax obligations, be sure to consult a qualified tax professional.
Options to Avoid a Second Mortgage Foreclosure
If you’re at risk of defaulting on your second mortgage, you may still have some options to avoid foreclosure.
Contact Your Lender Early
First things first, contact your lender as soon as you realize you will have trouble making your payments. Lenders prefer repayment over foreclosure – especially with a second position lien – and will likely work with you to bring your loan into compliance.
Potential options that you may have through your lender include:
- Forbearance: A temporary break from making your payments, often between 3 and 12 months, allowing you to catch up on your finances.
- Repayment Plan: You resume your regular payments, adding an extra amount each month to bring your loan current after a set period.
- Loan Modification: Your lender can adjust the terms of your mortgage – such as the interest rate or repayment period – to make your payments more manageable.
Refinance or Consolidate Loans
If you have suitable equity in your home, you can refinance or consolidate your mortgages into a single payment to lower your interest rate and monthly housing costs, and reduce the risk of foreclosure.
Keep in mind, however, that you will need to meet lender credit requirements, and borrowers with numerous late payments may have difficulty getting approved. If you plan to refinance or consolidate your loans, do so as early as possible.
Lump-Sum Settlement
In many cases, you can negotiate a lump-sum settlement for a portion of the balance you owe on your second mortgage. This option allows you to settle for less than you owe. For lenders, it helps avoid the potentially lengthy and costly foreclosure or deficiency judgment process.
The amount that your lender may be willing to accept as a settlement can depend on various factors. Oftentimes, you may settle for anywhere from 50% to 90% of the amount owed, depending on negotiations.
Short Sale or Deed-in-Lieu
If you’re underwater on your mortgage and facing imminent foreclosure, you may want to consider a short sale or a deed-in-lieu. Both options result in you losing your home, but they can help you avoid the foreclosure process and potentially prevent a deficiency judgment.
In a short sale, you put your home on the market for less than you owe on your loans. Both mortgage providers agree to it, however, and the primary lender would typically have to be willing to share a portion of the proceeds with the second loan holder.
With a deed-in-lieu, you transfer ownership of the property directly to your lender. This is the primary loan holder, so again, negotiations with the subordinate lender would still be needed to obtain approval and satisfy the second mortgage.
Bankruptcy
In some circumstances, filing for bankruptcy may be the most practical option if you default on your second mortgage, especially if your other debts are considerable.
- Chapter 7 Bankruptcy: Under Chapter 7 bankruptcy, you can liquidate your assets and settle your debt for less than you owe. This likely involves you selling your home, although it would prevent your lender from seeking a deficiency judgment.
- Chapter 13 Bankruptcy: Chapter 13 bankruptcy allows you to work with your courts to establish a repayment plan, typically between three and five years, that will enable you to bring all of your existing debts, including your second mortgage, current. This option would prevent foreclosure and help to keep you in your home.
Myths & Misconceptions About Second Mortgage Default
There’s not as much information out there regarding second mortgage default as there is about defaulting on your primary loan, so let’s address some of the most common myths and misconceptions:
“A second mortgage can’t foreclose before the first.”
False. Loan position has nothing to do with a lender’s ability to foreclose. If you default on your second mortgage, your lender can file for foreclosure even if your primary loan is current.
“If the lender doesn’t foreclose, the debt disappears.”
False. Even if your second mortgage lender doesn’t foreclose, you’re still obligated to repay the debt, and they may be able to sue you for the full amount owed.
“Defaulting on a second mortgage is less serious than a first.”
False. Defaulting on a second mortgage is just as serious as defaulting on a first and can still lead to the foreclosure of your home.
“You can’t negotiate with second mortgage lenders.”
Usually false. While a second mortgage lender is not required to negotiate the terms or repayment of your loan, they typically prefer to work with you rather than go through the foreclosure process.
What Homeowners Should Do Immediately If They’re at Risk
Are you at risk of becoming delinquent or defaulting on your second mortgage? The first thing you should do is to contact your lender and be honest about your situation. Explain why you aren’t currently able to make your payments and try to work out a plan to catch up on your loan.
However, if that’s not possible, these are the next steps you should take:
- Assess your current home equity by comparing the total amount you owe to your property’s estimated value.
- Determine the likelihood that your second mortgage lender will opt for foreclosure. Is your home worth enough to pay off your primary mortgage and have suitable proceeds remaining?
- Review your loan documents and state laws to understand whether your lender has any recourse beyond foreclosing on your home.
- If practical, consider refinancing or negotiating a lump-sum settlement to pay off your second mortgage.
- Decide whether filing for bankruptcy is a viable option to avoid foreclosure, but be sure to consider the long-term impacts.
- Seek legal or HUD-approved housing counseling if needed before making any major decisions about your home or finances.
Worried About Defaulting on a Second Mortgage?
Defaulting on a second mortgage can severely impact your credit and lead to the foreclosure of your home. You may also be on the hook for a deficiency judgment on any additional balance owed. If you’re at risk of foreclosure, speak with your lender and review all available options to bring your loan current.
If refinancing or consolidating into more affordable monthly payments may be a practical solution, be proactive and begin the application process with Refi.com today!
