The Consequences of Defaulting on a Second Mortgage

Defaulting on a second mortgage may result in a variety of circumstances since the loan is subordinate to the primary mortgage. A subordinate loan means that the lien your second lender has on your home takes a lower priority than the lien the first lender has on your home. When you take a second mortgage, you collateralize the equity you have built in your home from making payments to your first lender. Most second mortgages take the form of home equity lines of credit; the main difference is a second mortgage is always secured against the home itself. A secured, subordinate loan default can take many forms.

Impact on Your Credit

Defaulting on any loan will cause a significant negative impact on your credit. Any time you are late on your mortgage payment, the lender reports this late payment to the three credit bureaus. The late payment appears as a negative mark on your report, and your FICO score drops. A default only occurs after a series of payments has gone well past due. You will receive notices along the way that your payments are 30, 60 or 90 days past due. Your debt may go to a collections agency, and your credit score will drop even more. If your interest rate is adjustable, you can expect to see a much higher interest rate and higher payments as a result of your lower credit score. Ultimately, when you receive your notice of default, your credit score will have taken a large hit.

When Foreclosure is Possible

Because a second mortgage is subordinate to a first mortgage, this secondary lender does not own the deed to the home outright. Instead, the lender can only attempt to recover the asset from you by purchasing your first mortgage outright. Even if your first mortgage is in good standing, the second lender can attempt to buy it and force you into foreclosure. Since the second lender has a lien on your home and a loan under default, they can force you into foreclosure even if you made payments on your primary mortgage. The result will be the liquidation of your asset as the lender recovers the funds lost on your second mortgage.

When Bankruptcy is Possible

Defaulting on one loan does not necessarily lead to bankruptcy. For most borrowers, however, defaulting on a mortgage is the most significant default that can occur. Most home owners have more equity in their home than in any other asset; further, most borrowers owe more on their home than on any other asset. When a borrower loses the equity in a home, they are left with a small fraction of their previous net worth. This can often set off a chain reaction in which a borrower cannot afford other debts. If the borrower has secured other debts against the home, then those debts will need to be paid immediately. As this happens very quickly, a borrower may be forced to completely liquidate assets to meet the many financial obligations. Defaulting on a mortgage can often lead to bankruptcy as a result.