First-Lien Vs. Second-Lien Loans: Key Differences

In the home-lending field, you’re likely to come across the terms “first lien” and “second lien” a lot, especially in the fine print of a contract or agreement.

Both refer to the nature of the debt. And while that sounds pretty technical, it has practical consequences for you, the borrower – in the cost of borrowing, especially, but in other characteristics of the loan too.

Basically, first-lien loans let you finance a home purchase, while second-lien loans let you tap into your hard-earned home equity. So, if you’re buying a home or thinking about borrowing against an existing one, understanding the difference between first-lien and second-lien loans is critical. Here’s what to know.

What’s the difference between first-lien and second-lien loans?

All mortgages and home-based loans are a type of property lien – a claim against your home that gives a lender a right to it should you default (fail to repay) the debt.

In real estate, a first-lien loan is a mortgage or primary mortgage. It’s the borrowing tool the homebuyer uses to finance the purchase. In contrast, second-lien loans are second mortgages – taken out, as the name implies, in addition to an existing mortgage on the property. They provide sums of cash, drawn against the value of the home. Home equity loans and HELOCs are types of second-lien loans.

Here’s the crucial difference: The holder of the first-lien loan has repayment priority if a borrower defaults on their debt or goes bankrupt. This means the second lienholder – the home equity loan or HELOC lender – generally needs to wait until the borrower’s mortgage lender gets repaid (usually by foreclosing on and selling the home) before it receives any compensation. That’s why mortgages are also known as first-position loans or senior debt, and home equity loans/HELOCs as second-position loans or junior debt.

Another crucial difference: the cost of borrowing is higher with second liens than with first liens.

Why do second-lien loans have higher interest rates?

Because they are backed by collateral, home equity interest rates are much lower than those of personal loans or credit cards (one of their primary attractions). Unfortunately, while they’re akin to mortgage rates, they’re not as favorable as primary mortgages or even refinance rates, generally running a couple of percentage points higher.

Comparing interest rates

Why are home equity products more expensive? It’s due to their second-place status on the repayment ladder: If you default, and your home is seized and sold, the lender recoups only after your primary mortgage lender does. “Since the second-lien holder is in a junior position, they may recover little, if anything,” says June Lu, a Washington state-based branch manager at Churchill Mortgage. “This makes second liens riskier for lenders and more costly for borrowers.”

There’s also less of a secondary market for home equity loans and HELOCs, so lenders can’t easily sell them to investors (as they often do with mortgages). They often have to keep these loans on their books.

All this “creates a situation where a lender or bank will charge a higher rate in return for the higher risk,” says Jessica Vance, a San Diego, Calif.-based loan officer with Anchor Funding. Of course, the exact offer an individual borrower receives reflects their financials: If you’re deemed very creditworthy – with few debts, a big equity stake and a high credit score – your interest rate could be quite competitive.

How do you get a second-lien loan?

Applying for a second-lien loan is similar to applying for a primary mortgage. You’ll need to provide detailed financial information about your income, assets and debts, and access to your credit history. You’ll go through a similar underwriting process, as the lender verifies all this information. Some elements are slightly different – the lender may not require a title search or title insurance if you have it from your mortgage – but the overall timeline is the same.

The lender will also do a home appraisal, to determine the size and dollar value of your equity stake – the portion of the home you own outright, minus the outstanding mortgage balance. That dictates how much you’ll be able to borrow. Most home equity lenders limit all your home-based debt to 80-85 percent of your property’s value. So the size of your primary mortgage will impact how big your second mortgage can be.

Because second-lien loans are considered riskier, borrowers need a strong financial profile to get approved – stronger in some ways than primary-mortgage applicants. Most lenders demand a credit score in the mid-to-high 600s at the minimum. You must also own at least 20 percent of your home free and clear.

What’s the significance of second lien loans?

While second-lien loans give you access to your home equity, it’s important to understand the consequences. Tapping into your equity reduces your ownership stake in your home, and dilutes its worth as an asset. The added debt burden is not without its risks.

Can a second-lien lender foreclose?

Your home equity loan or HELOC is secured by your home, so missed payments could have serious consequences. If you get 90 or 120 days behind, your second-lien lender can start foreclosure proceedings on your home – even if you’re in good standing with your primary mortgage – and sell it to recoup its debt.

“Either the first-position or second-position lender can agree to settle for less prior to the foreclosure, allowing what is commonly known as a short sale,” Lu says. “If the foreclosure sale doesn’t cover what is owed on the second lien, the lender could pursue you for the remaining balance, unless state laws or loan terms specify otherwise.”

How can a second-lien loan affect a primary loan?

As noted above, the size of your first-lien loan affects how big a second-lien loan you can get. But the second lien can also impact your first lien – specifically, your ability to refinance it.

If you refinance your primary mortgage, your second mortgage will become the oldest loan, and have repayment priority if you default. The refinance lender won’t agree to that. You’ll need to get the second-mortgage lender to agree to resubordination, ceding the first claim in the event of default to the primary lender again, and pay it a fee to do so. If it won’t agree, you’d have to pay off the second lien, or find a lender who’ll refinance both mortgages simultaneously.