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Many homeowners with severe financial difficulties have both a first and second mortgage. Faced with foreclosure and perhaps even bankruptcy, some may be tempted to opt out of paying for their second mortgage. After all, the holder of a second mortgage is in a subordinate position to the primary lender—in a foreclosure, they don’t get a dime until the primary lien is paid in full, so they might not be in a position to foreclose immediately.
This plan sounds clever on the surface but has significant consequences in practice. The second mortgage holder still has several options.
Let’s look at the potential consequences of not paying a second mortgage.
Can a Second Mortgage Foreclose?
Yes, a second mortgage lender could foreclose.
Even if the second lender decides not to foreclose because they can’t get anything out of the property, that doesn’t mean they’re going away. Eventually, once your home value increases or you pay down your primary mortgage enough to build equity in the property, they will be back—and they will foreclose.
The secondary lender has options for immediate action, too. They may just purchase the first mortgage from the primary lender and then foreclose. It’s pretty easy to do—banks often sell loans to each other, and this helps ensure they get something out of your loan.
Or the primary lender may even purchase the second loan so they can foreclose on you. Once they learn you’ve defaulted on the second mortgage, they may figure it’s in their best interest to take action before you start defaulting on their loan, too.
Your Credit Score Will Decline
You’ll take a significant hit to your credit rating if you default on any mortgage, first or second. Some people may figure this would be a worthwhile trade-off for staying in their home, but you’ll find yourself paying a lot more for credit—if you can get any.
Living without credit cards is one thing, but there are situations where credit can help you in a pinch. Suppose you need a new car to commute to work with. If you continuously default on your second mortgage, your credit will drop, and lenders may not finance a vehicle.
Not only will your credit get worse, but you’ll incur late fees if you stop making your payments on your second mortgage, making the current situation worse.
» MORE: See today’s refinance rates
How to Stop a Second Mortgage Foreclosure
Refinancing or modifying your loan terms is the easiest way to lower monthly mortgage payments. Lenders will want to help you with this—it’s in their best interest for you to continue making payments, too.
If you’re successful, your credit score will have little to no impact. A mortgage lender or broker can help you determine if you qualify.
Qualifying for a Refinance
You’re most likely to qualify for a refinance if you have a good credit score, interest rates are lower now than when you locked in, and you’ve built at least 20% equity in your home.
If you meet any of the above criteria, there’s a good chance that you can refinance for a better rate and reduce your monthly payment.
A better credit score means you’re a lower risk to the lender, and they can give you a lower interest rate—significantly lowering the lifetime costs of your loans. If the market has changed since you got your loan and interest rates have dropped, you can get a lower interest rate by refinancing, even if your credit score has stayed the same.
When you’ve built 20% equity in your home, you can get rid of private mortgage insurance (PMI), reducing your monthly payments.
If the rates and conditions of your loan are good enough, you can refinance both your primary and second mortgage into a single loan, eliminating your second loan problems.
However, when you refinance your primary mortgage, your secondary mortgage lender must agree to subordination. Subordination is a process where the priority of the liens on your property is determined. The primary mortgage typically holds the first lien position, while the secondary mortgage holds the second one.
If you modify your primary mortgage with a subordination requirement, the secondary mortgage lender agrees to maintain its subordinate position even after the refinance. In the event of foreclosure, the primary mortgage lender gets paid first, followed by the secondary mortgage lender.
Qualifying for a Loan Modification
Unlike a refinance, a loan modification doesn’t replace your current loan with a new one. Instead, a loan modification alters the current terms of your existing loan.
Loan modification programs are designed to help homeowners keep their homes—most lenders have their own loan modification programs, but there’s also the government-sponsored Home Affordable Modification Program (HAMP).
These loan modification programs usually lower interest rates or extend the length of your loan term, reducing your monthly payments.
To qualify for a loan modification, lenders will require that you are experiencing financial hardship. If you’re struggling with making secondary mortgage payments, you likely already meet this requirement. But the most essential requirement is proving you can afford to make payments on a modified loan plan.
To prove that a loan modification plan will work for you, you must do a trial phase with the new payment plan for at least three months.
Last Resort Options
It might only make sense to stop paying on a second mortgage as a last-ditch negotiating tactic when the lender refuses to modify or refinance the loan or the secondary mortgage owner refuses to resubordinate.
The only reason for doing this is to pressure the lender into agreeing to new terms, and it’s a high-risk tactic—you’ll take a hit on your credit and could lose the home to foreclosure. Purposefully defaulting is one of those cases where you should check with an attorney before proceeding.