Second Liens Are Getting Paid First
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- Peter King | December 15, 2010
Borrowers who default on their primary mortgage often strive to stay current on secondary liens, despite the difficulty second lien holders face in trying to foreclose on underwater properties, a new report has found.
Such homeowners may be striving to maintain access to home equity lines of credit at a time when finances are tight or seeking to prod their first lien holders into modifying the loan, according to the report, published last week by the Philadelphia Federal Reserve.
In addition, homeowners who are current on their first liens were found to rarely default on second mortgages, even though the report described that as a viable strategy for fending off foreclosure.
“Given the degree of second liens that have been underwater during the current mortgage crisis and given that second lien holders are not likely to foreclose on many of these underwater second liens, it is surprising to find that the default rate for first lien mortgages far exceeds the default rate on the second lien mortgage for the same property,” read the report, which was released Dec. 9.
Trend emerged with mortgage crisis
The report also found that the disparity between first- and second-lien defaults is a trend that has emerged only since the start of the mortgage crisis. First- and second-lien mortgage defaults were found to run about even through 2005, then first-lien defaults began to increase faster in 2006. By one measure, by 2009 first-lien mortgages were defaulting (90 days past due) at twice the rate of second-lien loans.
About one-third of those who defaulted on their first liens were found to stay current on their second mortgages, whereas 80 percent of those who defaulted on second liens also defaulted on their first. Those figures minimize current differences between the two groups, as they cover the period 2004-09, during the first half of which there was little or no difference in first- and second-lien defaults.
Significantly, second-lien holders were far more likely to default if they had a home equity loan, as opposed to a home equity line of credit (HELOC). That suggests they may be trying to maintain access to their credit line, which would get cut off if they were to default, the report said.
Loan modifications a major influence
Homeowners involved in mortgage loan modifications turned out to be far more likely to default on a primary mortgage versus a second lien. For that group, 42 percent of those who defaulted on their first liens kept their second liens current, whereas 95 percent of those who defaulted on a second lien defaulted on their first as well.
Because some lenders require homeowners to be as much as 90 days past due on their mortgage to be considered for a loan modification, it was suggested the process actually encouraged borrowers to default on their first lien. Since primary mortgages are the ones that are typically modified, the report suggested those are the ones borrowers have an incentive to default on.
The report’s authors said it was somewhat surprising to find that underwater homeowners – those who owe more on their mortgage than their home is worth – rarely default on their second liens alone. They had expected to find that homeowners in negative equity would be more likely to strategically default on their second lien and keep paying the first, as the second lien holder would be able to recover little or nothing in foreclosure. However, this did not appear to be happening.
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