If you find a mortgage lender that will refinance your first mortgage, consider asking for a loan large enough to pay off your second mortgage, too.

Getting a mortgage refinance these days is like playing a video game-you have to navigate through a maze of paperwork and bureaucracy. And just when you think you're going to emerge victorious, another roadblock shoots up in front of you.

For many homeowners, that roadblock is going to be the lender who holds a second mortgage, also known as a home equity loan. This lender will have to approve first mortgage refinances-and right now, they may not be willing to do so.

Home equity/second mortgage lenders are, like everyone else, worried about getting repaid. They've absorbed too many losses in recent years, and they'll do nearly anything, including alienating their customers, to avoid taking further hits.

Case in point

Consider this scenario. Mrs. Jones has a mortgage refinance offer that will save her $350 a month on her first mortgage payment. She also owes money on a second mortgage, but doesn't want to pay it off with the first mortgage refinance.

In normal housing markets, the home equity lender might be pleased that she's going to lower her payment and reduce her debt service ratio. Therefore, blocking that refinance may not be a consideration, unless she never pays her bill on time, or her total mortgage debt balance exceeds 80 percent of the home's value.

Unfortunately, there's nothing normal about today's housing market. The deal breaker is the trend in housing values; they're going down instead of up. This is a primary concern for home equity lenders-if Mrs. Jones is foreclosed, the home equity lender who holds the second mortgage gets nothing unless the proceeds are sufficient to repay the primary mortgage lender first. In other words, if the value of her home drops too low, the second mortgage lender essentially loses its collateral on the debt.

Take it or leave it

The second mortgage lender can't do anything to address those falling home prices unless Mrs. Jones defaults. While the lender may want to demand full repayment because of the rising credit risk, that's not an option-it's illegal.

In fact, outside of a default, the only time the second mortgage lender has much power to do anything is when Mrs. Jones wants a first mortgage refinance. Blocking the first mortgage refinance is the second-position lender's attempt to strong-arm her into paying off that debt. The hope is that she'll decide to roll her home equity debt into the first mortgage refinance. The second mortgage lender can then walk away with its cash and the security of knowing there's one less potential default on the books.

The worst part is that this is a video game that has no cheat codes. The home equity lender is entirely within its rights to block a first mortgage refinance. It may seem unreasonable and nonsensical, but there isn't much a homeowner can do about it.

Published on April 8, 2009