First mortgages: everything your client needs to know

While many first-time home buyers will get one, a first mortgage does not only mean the first loan the borrower has taken out on their first home. Here is everything you need to know about a first mortgage, how it differs from a second mortgage, and a refresher checklist for first-time home buyers.

This is part of our client education series, and we encourage all of the mortgage professionals who frequent our site to send this to their clients who are struggling to understand how to get their first mortgage.

First mortgage: Everything you need to know

A first mortgage is the primary loan taken out on a home. When taking out a mortgage, your lender will place a primary lien on the home, which gives the lender the first claim to the home should you default on the mortgage. If other lenders have a lien on your property, they would be secondary to the lender of the first mortgage. In the case of refinancing, the refinanced mortgage replaces the first mortgage position.

It is important to distinguish that the first mortgage is not necessarily the first loan the borrower gets on his or her first home. Instead, it is the original mortgage taken out on any one home.

Read more: Refinance: Everything you need to know

How a first mortgage works

The cost of purchasing a property is usually financed by a first mortgage. However, you may have to pay a percentage of the cost up-front as a down payment, depending on the type of first mortgage you get.

The next step is to assume responsibility for making monthly payments on the mortgage. These payments usually consist of a portion of the amount you borrowed as well as the interest, property taxes, and homeowners' insurance. Portions of your payments go into these areas until the loan is repaid.

Senior vs. junior lien

The first mortgage is also occasionally referred to as the senior lien position. Any second mortgage is referred to as a junior lien. A senior lien takes priority over a junior lien.

Here is how it works:

1. You bought a home with a mortgage.
2. Afterward, you took out a second mortgage in the form of a home equity loan.
3. If you defaulted, the mortgage lender on your first loan would be able to claim first the funds from the foreclosure sale.
4. The second mortgage lender, on the other hand, would be able to claim the remaining proceeds, if there are any.
5. If you have multiple liens, the same priority will continue.

There are, of course, exceptions to the chain of priority. For example, any property taxes you may owe will usually be repaid first before any other claim. Also, if you file for bankruptcy, a court will decide the claim that takes precedence.

Example property purchase

You purchase a $300,000 property with a $240,000 mortgage, which is the first mortgage on the home. After a few years, the value of your home increases to $330,000. By this time, the balance of your first mortgage has been paid down to $100,000. In order to do some home improvements, you take out a home equity loan, or a second mortgage, worth $50,000.

Then you run into financial difficulties, are unable to make the payments, and fail to work out a fix with your mortgage lender, which chooses to recoup its losses by starting the foreclosure process. If your property sells at auction for the $330,000 the home is currently valued at, the first lender will recoup the entire $100,000 still left on the mortgage. The second lender, meanwhile, will be able to recoup the $50,000 price tag of the second loan.

If, however, the property sells under the $330,000 valuation, the first mortgage lender may only get a portion of the money and the second lender may get nothing.

Checklist to get a first mortgage

Getting a first mortgage does not necessarily mean you have never owned a property. If you do qualify, you may be able to unlock numerous benefits such as low- or no-down-payment loans, grants, and down payment assistance, among others. Eventually, these bonuses can add up and save you a lot of money.

One way to qualify is if you have not owned your primary residence in the previous three years. There are even assistance programs available for first-time home buyers that offer financial aid in areas targeted specifically for redevelopment or repeat home buyers. It is important to know beforehand, depending on where you reside, which first-mortgage benefits might be available to you.

While getting a first mortgage does not necessarily mean you have never owned a home before, it is common that most first mortgages are purchased by first-time home buyers.

Here is a checklist that will help you secure that first mortgage:

1. Financial checkup
2. Mortgage shop
3. Research lenders
4. Get pre-approval
5. Submit application
6. Start underwriting
7. Prepare to close
8. Close

Here is a closer look at the different steps to getting a mortgage:

1. Financial checkup

This is essentially to ensure that you are financially ready to own a home. Take a closer look at your debt, for instance, and how much money you have in the bank for a down payment and closing costs.  It is important to review your finances as well since lenders will scrutinize your account(s).

For this reason, it is important to improve your financial health (debt, credit history) prior to applying for a mortgage. This also includes building up your credit score, since it will determine your interest rate.

2. Mortgage shop

Since there are so many types of mortgages on the market, you will want to identify which will work best for you. Here is a list of considerations:

1. Conventional loan: While this type of loan has more strict qualification requirements, they are usually a strong option if you have good credit.
2. Fixed or adjustable rate: For a fixed-rate mortgage, the interest rate remains the same over the life of the loan, meaning the rate you agree to in the beginning will be the rate you keep until you sell the property or refinance.
   1. For an adjustable-rate mortgage, you will have low introductory rates that begin as fixed but can fluctuate. This might be the better option if you do not plan to stay in the property long.
3. Mortgage term: 30-year mortgages are most common, offering generally smaller monthly payments but more interest over the life of the loan. Going with a short-term loan (10- or 15-year) means you will pay more in monthly payments but less in interest.
4. Down payment: If you make a down payment of less than 20%, you will be on the hook for private mortgage insurance. However, if you go with a 3% down payment (about the lowest) and build up 20% equity in your property, you can cancel your PMI.

Read more: What is the best mortgage advice that you can tell your clients?

3. Research lenders

Some lenders you might consider include online non-bank lenders, traditional banks, and credit unions. If you want a particular type of mortgage for construction, for example, you can choose specialty lenders.

Either way, you should consider the following:

• Best line of communication (in-person, texts, emails, phone)
• What the sample rate includes specifically
• The minimum qualifications
• Which unique programs and benefits may be available to you

4. Get pre-approval

Getting pre-approval shows the seller that you can make a legitimate offer up to a specific price. It will also help you see what your mortgage will cost. Since you have already gone through the trouble of digging out all your pre-approval documents, you should get pre-approved by at least three lenders. Learn more about mortgage pre-approval advice here.

5. Submit application

When you formally apply for a home loan, you will have to submit the most up-to-date financial information you have. This is true whether you have been pre-approved or not. While the specifics may differ depending on the type of mortgage you get, common application documents include:

• Pay stubs from previous 30 days
• Tax returns from previous two years
• Proof of income
• Bank statements
• Debt details
• Social security number and ID
• Recent deposits in bank accounts

6. Start underwriting

The lender will determine during the underwriting process if you are eligible for the mortgage loan. Some factors lenders typically look at include credit and job history, debt-to-income ratio, and current debt obligations. A home appraisal to determine the value of the property is also included in this step.

7. Prepare to close

To prepare for closing, you will want to take these steps to complete the process:

• Buy homeowners’ insurance
• Buy a lender’s title insurance policy
• Do a final walk-through of the property
• Review your updated loan estimate and closing disclosure
• Get the money to close

8. Close

At this point, you should ask whatever questions you can so that you can fully understanding what you are signing and what you are paying.

What is the difference between a first and second mortgage?

Typically, the first mortgage is used to purchase a property and a second mortgage can be used for any number of reasons, such as:

• Making home renovations
• Consolidating debt
• Paying for health-care costs
• Funding college education
• Taking a vacation

When it comes down to it, the major difference between a first mortgage and a second mortgage is the first claim to the home if there is a default on the loan. If you are unable to make your monthly mortgage payments, your first lender can foreclose on the home and use the returns to pay the remainder of the loan.

It is only after the first loan is paid off that the second lender can then claim any portion of the returns. This is the main reason that most second mortgages usually carry higher interest rates than first liens.

Second mortgages present a greater level of risk since the first lender assumes the right to claim the home if you fail to make your payments, meaning it is very possible that the second lender will not receive anything from the home sale at all. In other words, the higher interest rate is an added layer of protection for the second lender.

Here is a breakdown of the major differences between a first mortgage and second mortgage:

First mortgage

• Could come with fixed or variable interest rates
• The property acts as collateral for the loan
• Primary lien; this means that lienholders receive payment first
• The eligibility of the borrower, and the loan type, determine the loan limits
• Depending on the down payment and the type of loan, it is subject to private mortgage insurance (PMI)

Second mortgage

• A home equity line of credit (HELOC) usually has a variable interest rate; a home equity loan usually has a fixed rate
• Like the first mortgage, the property acts as collateral for the loan
• Secondary lien; this means that lienholders receive payment after primary lien holders
• The limit of the secondary mortgage loan could be anywhere from 75% to 100% of the home’s equity
• Private mortgage insurance typically does not apply; however, taking out a HELOC or a home equity loan could impact the PMI requirements of the first mortgage

Another major difference between the first mortgage and the second mortgage is how the tax code treats each. It is important to know beforehand how taxes may impact your first and second mortgage, such as what, if any, limits are there in order to deduct interest on the first mortgage. One good question to ask is, can you deduct interest on home equity and second mortgages?

What are the benefits of the first mortgage?

There are two major benefits of the first mortgage, including:

1. Priority: One of the major benefits of the first mortgage is that it is the primary lien again your property, which also means that it takes payment priority over all subsequent mortgages. Because your home is used as collateral against your mortgage loan, the first mortgage is paid before any other mortgage lien on the home if you default or the property sells.
2. Less risk: Because it takes priority, the first mortgage is also less of a risk compared to the second mortgage. For this reason, the interest rate is usually lower on the first than it is on the second, since the lender is less assured of recouping any losses on the property.

Getting that first mortgage and your dream home

When buying your dream home, it is critical that you know the steps to securing a mortgage and know what is expected of you, both in terms of finances and documents. But keep in mind that a first mortgage does not only pertain to first-time homeowners; it also simply means the original loan taken out on a property.

And more than that, it could provide you benefits—and savings. It is important to speak with a knowledgeable mortgage professional in your area to fully understand how your first mortgage could work for you.

Have experience with a first mortgage, or some advice you feel that we missed? Let us know in the comment section below.