Thinking about refinancing? A second lien may be a factor in whether or not you can.
If you've taken out a second lien on your home, it is subordinate to your primary mortgage and must be dealt with. It can't be ignored, and it doesn't matter whether it's a home equity line of credit, a home equity installment loan or any other kind of loan.
"You have one of two options" when dealing with subordinate financing on your house, says Scott Stein, president of Xetus, a technology company that helps mortgage originators manage second liens. "You either need to pay off that second, or you need to get the lien-holder of that second to agree to remain in a subordinate position to the new first."
Back in the days when home values were "always" going up, borrowers would use the cash they received on top of their new first mortgage to pay off the second.
"It was no big deal," says Stein. But since the housing crash, "people haven't had nearly (enough) equity in their homes to do that. ... So they have, more and more, chosen the path of going to the second lender and getting him to agree to remain" in the second position.
Getting the second lender to agree can be tricky, though, Stein warns.
"At some financial institutions, the answer has been, 'No, we won't do subordinations.' They won't approve a request," he says.
Others "will not decline, nor will they approve you. Or they might say they will approve, but reduce the line amount."
If second-lien holders are willing to consider maintaining the second's subordination with a new first mortgage holder, they will be looking at the risk of being in a secondary position if you should fail to make your payments. That means if you default, the second lender won't receive any money until the first lender is paid in full.
And recently, says Stein, that's something that banks have "taken a much closer look at."
One factor is whether you are taking any cash out of the deal, a situation lenders now look at with reluctance. Another is the loan-to-value ratio of not just your new first mortgage, but of the new first and the second taken together.
Stein says the best bet for refinancers is to have cash on hand or in reserve. "The more you can bring to the table on the refinance, the better your ratios are going to look," he says.
Some borrowers, either honestly or dishonestly, do not think to mention the fact that they have a second lien when they try to refinance. But it will not be overlooked, because the second lender almost always takes a hard look at your credit record, liabilities and the title to or liens on the property.
"It's always best to mention it upfront," Stein says. "It's going to come up."
It is not your responsibility to contact the second-lien holder when you start the refinance process. That's the primary lender's job. But it is to your advantage to understand the process and the thinking involved.
While banks may be cautious when it comes to changes that could affect their risk, they also often have an interest in retaining current customers. That could work to your benefit, particularly now that there has been a run-up in mortgage rates and new loans are in shorter supply.
Some banks are so concerned about this they have been using systems like Xetus, which processes second-lien subordination requests. The program looks for second liens and identifies the owner or lender. If the primary lender also holds the second, the system alerts the bank's call center to contact the borrower in an effort to retain the loan.
Banks "are more likely to approve subordination if they hold the first lien," according to Stein. But if not, they may offer you a sweeter deal on a new first mortgage in order to keep your business.
Don't expect your bank to take the first step, though. If you want to make sure you will be offered the best terms possible, you should be proactive.
Banks today are "after wallet share," Stein says. "So it never hurts to check multiple sources for loans. It's so easy to do that online for potentially a significant amount of savings over the life of the loan."