Being late is good for making dramatic entrances at cocktail parties, but the advantages stop there. Arrive late to work and you could get fired. And if you slip behind on your second mortgage payments, you risk losing your home.
Default sets the wheels in motion
Second mortgage lenders can take action against you once your loan is in default. As soon as you fail to meet the terms of your loan agreement, you'll trigger a default. Partial, late, or skipped payments are common examples of failing to pay as agreed. At first, your lender may give you some time to sort things out. But if the lateness continues, the lender will pursue one of the following options.
1. Foreclosure. The second mortgage lender cannot foreclose without paying off the first mortgage lender. Therefore, this course of action only makes sense when you have sizeable home equity. In that scenario, the second mortgage lender could sell the property and raise enough cash to pay off both home loans. More commonly, the equity value is too low to support a foreclosure. In that case, your second mortgage holder would try to initiate a forbearance plan or make a settlement offer
2. Forbearance plan. This is a temporary, negotiated reduction in your monthly payments. If you're facing a temporary hardship, for example, you might negotiate a six-month payment suspension. Generally, your interest will accrue during this time and the lender may require you to make larger, catch-up payments after your six-month stay.
3. Settlement offer. If your situation appears to be more than a temporary hardship, your lender may make a settlement offer, a lump sum amount they'll accept to close out your loan. These offers can vary widely from 10 to 70 percent of your existing balance, depending on the loan history.
4. Silent accrual. If you can't agree on a settlement plan and the lender won't foreclose, your interest will simply continue to accrue. Once you sell the home, the lender will take back the money you owe, plus all of the accrued interest, because it has a second lien on your property. This will cost you, particularly if the housing market recovers and property values rise. Also, if you choose to keep the home indefinitely, you would not be able to obtain another mortgage. The presence of the accruing second lien essentially eats away your equity, which offsets most of the advantages of home ownership.
Credit score consequences
In all the above scenarios, your credit score will take a hit. At a minimum, your lender will report that you aren't paying as agreed. Worse, you could end up with a foreclosure or judgment in your credit file.
You may have heard that it's better to pay your second mortgage late rather than your first. This conclusion has a small bit of accuracy, but only because the foreclosure process is more cumbersome and less fruitful for a second mortgage lender. Even so, being late on your second mortgage could still lead to foreclosure, or to some other, equally unpleasant alternative.