You need mortgage financing if you can’t pay cash for a house (most people can’t). When you apply for a mortgage, you’ll likely hear many terms, including first and second mortgages. Both can help you buy a home, but they have different scenarios.
Before you borrow money, you should know the answer to ‘What is a first mortgage?’
Here’s what you should know.
Understanding a First Mortgage
The first mortgage is the first lien on your property. For most, it’s the loan used to buy the property. For example, if you buy a home for $200,000 and put down $20,000, you must borrow $180,000, which would be your first mortgage.
First mortgage lenders have first lien position on your home. This means if you default on your mortgage, the first mortgage lender has first dibs on the sale proceeds to make up for the funds they lost.
What are the Uses for a First Mortgage?
Primarily, a first mortgage is used to buy a home, but you may refinance your first mortgage throughout its term too.
You borrow money from a bank when you use a mortgage to buy a home. In exchange for the loan, you use your home as collateral. The mortgage deed allows the lender to foreclose on your property if you miss too many payments. It’s a legally binding document that you sign.
Most lenders require a down payment or your own money invested in the home before they’ll lend you a first mortgage. For example, FHA loans require a 3.5% down payment, and then lenders can provide the remaining 96.5 percent to buy the home. However, some loan programs have much higher down payment requirements.
You can also use a first mortgage to refinance. Say, for example, you have a 30-year term on the loan used to buy your home, but your rate is higher than the current rates. You can find a lender to refinance your first mortgage.
When you refinance, you pay off your first mortgage and take out a new one. You may refinance into a loan with a shorter term or restart the term of your current loan. For example, if you had a 30-year term and made payments for three years but then refinanced into another 30-year loan, you add three years onto your term.
You can also refinance your first mortgage to use your home’s equity. You may be eligible to withdraw the difference if you have over 20% equity in your home. However, most lenders require you to leave 20% of your equity untouched.
In this case, you’d take out a larger first mortgage but be able to use the funds for other purposes, such as debt consolidation or paying for a large expense.
First Mortgage vs. Second Mortgage – What’s the Difference?
As you learn the answer to what is a first mortgage, you may wonder then what is a second mortgage.
Like the first mortgage, a second mortgage uses the property as collateral. However, the second mortgage lender is in the second lien position rather than the first lien position. This means the second mortgage lender is second in line to receive proceeds if you default on your loan.
Because the second mortgage lender takes a higher risk, the rates are usually higher on these loans.
There are several types of second mortgages, including a fixed-rate home equity loan and a line of credit or HELOC.
The fixed-rate home equity loan provides the funds to you in one lump sum. You make fixed monthly payments for the entire term. The HELOC provides you with a line of credit to use how you want. You can make interest-only payments for the first ten years and reuse funds as you repay them. After ten years, the loan requires principal and interest payments for the remaining term.
Example of a First Mortgage and Second Mortgage
Here’s how a first and second mortgage might work if you used both to buy a home.
You found a home for $250,000. The seller accepted your offer, but you only have $25,000 to put down. So you need to finance the rest.
Your best option is to borrow 80% of the home’s price in a first mortgage and 10% in a second mortgage, with your 10% down payment making up the rest.
Because you’re borrowing only 80% of the sales price in your first mortgage, you won’t pay Private Mortgage Insurance. Instead, the funds from the second mortgage will make up the difference.
Your first mortgage lender gives you a fixed-rate loan for 30 years, and you have a home equity loan for $25,000 to make up the difference. Both loans close and fund simultaneously, so you hand the seller the $250,000 you promised to pay.
The first mortgage lender takes first lien position even though the loans closed simultaneously. The second mortgage lender takes a secondary or subordinated position. If you default on your loan, the second mortgage lender is the last to get paid.
When you wonder what is a first mortgage, it’s the mortgage that primarily helps you buy a home. However, it can also be helpful if you need to refinance in the future.
The first mortgage lender has the first lien position on your home and first dibs to the home’s proceeds if you default. As a result, you’ll typically get the best rates and terms on your first mortgage because any mortgage in a subsequent lien position doesn’t have first dibs to the funds.
If you have questions or concerns about how a first mortgage works or if you need a first and second mortgage to buy a home, contact Loan Factory today to see how we can help.