Sometimes known as secondary liens, junior liens are lending obligations that are attached to properties that already have some type of primary or first lien attached. This type of arrangement is not unusual with real estate. In fact, many homeowners make use of this financial resource to secure the funds needed to successfully complete a project.
How Does a Junior Lien Work?
Junior liens are associated with second mortgages. Homeowners may take out second mortgages as a way to finance improvements to the properties, consolidate debt, or manage just about any other project that involves a need for cash. The second mortgage contract entitles the lender to lay claim to the pledged collateral in the event the debtor defaults on the mortgage.
One way a junior or second lien is different from a primary lien is that the prior obligation must be settled first in the event of a loan default. Perhaps the homeowner is no longer able to pay the primary and secondary mortgage. In this scenario, the primary mortgage holder would seize the property, sell it for enough to cover the remaining balance on the first mortgage plus any applicable fees. Once that obligation is settled, the lender holding the junior lien has access to any remaining cash. Hopefully, there is enough money left to settle the second mortgage. If there is anything left, the former homeowner receives that remaining sum.
How Does the Junior Lienholder Assess the Risk?
A lender who is evaluating an application for a second mortgage will look closely at the applicant’s credit rating and also check the comments submitted to each of the three major credit bureaus. Attention is paid to the amount of equity in the property that will be used as collateral. Many secondary lenders will only approve applications when the total requested amounts to no more than 70-80% of the property’s equity at the time of the application.
The applicant’s debt to income ratio is also scrutinized. The goal is to make sure the applicant has enough net income to make the payments on all monthly obligations. That includes both mortgage payments, utilities, food, and often unsecured debt like payments on credit card balances.
What Would Cause the Debtor to Enact the Lien?
Failing to make payments on time will lead the lender to foreclose and seek to lay claim to the equity used as collateral. In effect, this means the junior lienholder becomes a part owner of the property. Should the homeowner attempt to sell the home, both the primary and the secondary liens must be settled in full. If a default occurs before the property sale, it’s not unusual in some states for the property owner to need permission from the junior lienholder to proceed with the sale.
What Happens to the Lien Once the Secondary Mortgage is Paid in Full?
After the debtor completes the repayment of the amount borrowed plus all interest and other fees, the lien or the claim on the property is relinquished. Many lenders provide documentation to the homeowner that confirms the lien has been released and there is no longer any claim on the property. At that point, the only remaining lien is the primary one. It will remain in effect until the first mortgage is settled in full.
Keep in mind that a secondary mortgage with a junior lien is still a debt. It should be paid according to the terms and conditions found in the loan contract. That means the homeowner must make sure the resources to honor the debt are present. As with any type of lending situation, it’s important to communicate with lenders if illness, job losses, or other events that temporarily make it difficult to remit payments occur. Many primary and secondary lenders are willing to work with debtors provided they contact them before any payments are past due.