The Consequences of Default on a second Mortgage

Second mortgages are primarily obtained to release equity from the home for purposes such as home improvements. Using this equity for debt consolidation is a popular reason for second mortgages but a very risky option for the borrower. To borrow against your home to consolidate debt is going against the sensible adage of not borrowing your way out of debt. 

A high percentage of second mortgages used for debt consolidation are likely to end in default when the mortgage holder cannot service the monthly payments. Typically the property has devalued and the mortgage holder has borrowed against equity which is now reduced.

It is important to understand that a default on a second mortgage can lead to foreclosure by the lender. This may not necessarily be the lenders first choice though as it is an expensive procedure which will only benefit the second lender if there is sufficient equity in the property to pay off both the first and second mortgage, and cover the legal and other costs of foreclosure. If the second mortgage lender does initiate foreclosure then legally the first lien on the property must be satisfied before the second.

If a lender does pursue foreclosure, and there is still a shortfall in the balance, then depending on the state you reside in there is the possibility of the lender obtaining a judgment deficiency at some point in the future. With the high level of foreclosures more lenders are beginning to apply for such judgments.

If you anticipate a problem with your mortgage payments it is best to contact your lender and try to negotiate an agreement which will avoid any foreclosure procedures. Lenders should be willing to assist as the cost of foreclosure may not be in their best interests with a first lien to be satisfied before they get their piece of the pie.

Options which you can discuss with your second mortgage lender include both forbearance and temporary indulgence. Forbearance can be granted and payments suspended for a set period after which the payments can be either made up, or added to the balance of the mortgage. With the latter case the missed payments would accrue more interest. A temporary indulgence may result in missed payments being incorporated into a repayment plan.

If you fail to work with the lender and simply go into default, then if it is not cost effective to initiate foreclosure the lender may well send your account to a debt collection agency. If you mortgage is retained by the lender and you fail to pay then the interest will accrue on missed payments, effectively eating into any equity you may build by making payments on the first mortgage.

If you can work with the lender to come to an arrangement until things improve this is obviously the best course to follow, rather than ignoring the problem. If you do miss payments or pay sporadically it will have a negative effect on your credit rating, but that is far preferable to facing the possible consequences of default leading to foreclosure.