Can a Second Mortgage Cause a Foreclosure?
A second mortgage is a loan on the equity of your home that is secured by the real estate property as collateral. This type of loan may offer lower interest rates than unsecured lines of credit, providing you with a cost-efficient means of obtaining money for home improvements, educational costs and other expenses. If you default on a second mortgage, your home may be at risk of foreclosure even if your payments are current on your first mortgage.
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Possessory Interest
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Because your home serves as collateral for a second mortgage, the lender has a possessory interest in the home until you pay off the second mortgage. This means that if you fail to make payments on the second mortgage, the lender can use the value of your home to cover the loan. The possessory interest gives the second mortgage holder the right to initiate foreclosure proceedings and sell your home to recover the balance due on the loan in the event of default.
Subordinate Interest
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Although the second mortgage holder has a possessory interest in your home, that lender's interest is subordinate to the interest of the primary lender. This means that if the second mortgage holder decides to foreclose on your property, your primary mortgage holder has first right to the proceeds of the foreclosure sale. If the sale price of the home is not sufficient to cover both mortgages, the second mortgage lender may not receive the full balance of the loan. This can make opting for foreclosure a risky prospect for a second mortgagor. If the second mortgagor does decide to foreclose, this action may also force your primary mortgagor to foreclose to avoid loss of equity under the second mortgage.
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Buyout
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Because the holder of your first mortgage has a primary possessory interest in your real estate property, it may opt to buy out your second mortgage if the second mortgage holder decides to foreclose on the property. This may stop foreclosure of your home for default on your second mortgage. In that case, the first mortgagor will control the balance of both loans, and determine the interest rate on the purchased second mortgage balance. The second mortgagor may also buy out the first mortgagor's interest.
Considerations
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The primary mortgage holder's decision to buy out the second mortgagor's interest in your home depends on the appraised value of the home and if it exceeds the sum of both mortgages. If the total of both mortgages exceeds the appraised value, buying out the second mortgage holder's interest would represent a substantial risk for the first mortgagor. In this case, the primary mortgage holder may determine that allowing the second mortgagor to foreclose carries a lower risk of loss. The total of both mortgages may not exceed the appraised value, however.
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