If you, like many homeowners, have a second mortgage on your home that you are having difficulty paying, you may have wondered what would happen if you stopped paying it. That generally depends on the current value of your home and whether your mortgage is underwater.
A second mortgage is a loan secured by your home that is junior, or subordinate, to another loan called the first mortgage; the first mortgage is typically the original loan you used to purchase your home. A second mortgage may be a home equity line of credit (HELOC), a piggyback loan (in an 80/20 loan, the purchaser puts no money down, finances 80% of the purchase price with a first mortgage loan, and finances the remaining 20% with a junior piggyback loan), or any other loan secured by the home.
Whether a mortgage is first or second generally depends on when the loan was taken out and recorded, although that’s not always the case. A lender refinancing a first mortgage will typically require other lenders to subordinate their loans to the refinanced loan, even though the refinanced loan is the newest loan and would be the most junior loan without subordination agreements from the other lenders.
The position of a mortgage--whether the mortgage is first, second, or even third--is important because, in the event of a foreclosure, the proceeds of the foreclosure first go to repaying the most senior lender (the first mortgage holder), then to all other lenders in order of seniority. If there isn’t enough equity to pay back the second or third mortgage holders, those junior lenders are out of luck.
If you can’t afford to make your monthly payments on both your first and second mortgages, you may be contemplating stopping payments on your second mortgage. (As a general rule, if you had to choose between paying your first or second mortgage, it’s always best to pay the first mortgage.) Whether the holder of your second mortgage will then foreclose depends primarily on the current value of your home.
If the value of your home is less than your outstanding mortgage debt, your mortgage is considered to be underwater. If your mortgage is underwater but the value of your home is greater than the amount you owe on your first mortgage, your second mortgage is partially secured.
If your mortgage is not underwater or your second mortgage is partially secured, and you stop paying your second mortgage, the holder of the second mortgage will likely foreclose because it stands to recover all or part of the money it loaned to you from the foreclosure. The greater the amount the junior lender stands to recover in a foreclosure, the greater the incentive the junior lender has to foreclose.
If the value of your home is less than the amount you owe on your first mortgage, your second mortgage is in essence an unsecured loan. What this means for you is that even if you stop paying your second mortgage, the holder of the second mortgage will probably not foreclose. Why? Because, in the event the junior lender forecloses, all the proceeds of the foreclosure sale will go to repaying the senior lender. The junior lender will have gone through the expense of foreclosing but will get no money out of it.
This doesn’t mean that the junior lender has no other remedy to recover the money it loaned to you. Even though foreclosure is not an option, the junior lender, being an unsecured lender, can sue you personally to recover the money. If the junior lender wins the lawsuit and gets a money judgment against you, the junior lender can garnish your wages, freeze your bank accounts, or place liens on other property you may own. (Bankruptcy may help reduce or cancel your obligation to repay an unsecured debt; see our section on Bankruptcy).
Stopping payment on your mortgage is a drastic step and is one you should take only after considering all other options. Your credit report will take a big hit, but if avoiding foreclosure and hanging on to your home is your top priority, it may be the right option for you.