Buying a home can feel overwhelming. Not only is it one of the most expensive purchases you’re likely to make, but the process can often be full of terms you don’t understand. One of these terms is “first lien.” What is a first lien, and how do you know if you need one? This article demystifies the home buying process by explaining what a first lien is, why you’d want one, and how to get one.
What Exactly Is a First Lien?
You might think that the term “first lien” references the residential mortgage on your first home. That’s not entirely true since it’s actually just the first mortgage on the property. For instance, if you have several mortgage loans on a single piece of property, the original loan is called the first lien or first mortgage. You might obtain a second loan if you want to complete some home-improvement projects or fund other expenditures through a home equity loan, and this involves borrowing against the home’s equity.
You might also have two mortgage loans when you purchase your property. The first mortgage is used for the majority of the purchase price without the down payment. This second loan would cover the down payment and any associated closing costs of the entire transaction. This type of action is called piggybacking, with the second loan considered a combo or piggyback loan.
The lender of the first lien expects you to pay the loan paid back in monthly installments, and this payment includes the principal and interest payments. In essence, the lender has a lien on the property since the home secures the loan. However, if you default on the mortgage, this first lender has the first chance to claim the home. The lender would have the home go through foreclosure and eventually sell it to collect the mortgage debt.
How Does a First Lien Work?
To understand what a first lien is better, follow this example. Say you purchased a home 10 years ago that was worth $300,000, but you were able to put down $50,000. You decided several years later to make some improvements to your home, so you secured a home equity loan of $75,000 to offset the costs. This original mortgage you took out to purchase the property is considered the first lien, and the home equity loan is the second lien.
Fast-forward until now, and you are experiencing some financial hardships and getting behind on your payments for both loans. As a result, the first lien lender begins the foreclosure process to recoup losses. If the home sells at auction for $325,000, the first mortgage lender can recoup all of the $250,000 remaining on the mortgage. The second lender gets the remaining proceeds. If the home sold for less, the first lender would receive the bulk of the money, while the second lender might not receive any at all.
How Can You Get a First Lien?
Securing a mortgage is the first step in homeownership, and you have several different options when it comes to obtaining one. However, before you even begin to worry about getting approval for a mortgage, you must complete a few steps.
- Sit down and document your monthly income and debt payments. When you meet with a lender you will need at least two months of pay stubs, so it’s best to start collecting those as soon as possible. If you’re self-employed or have inconsistent income, the underwriting process becomes a bit trickier. In those instances, you might need to submit several years of tax returns.
- Check your credit. It’s best to obtain your credit score and your credit report to ensure there aren’t any discrepancies. According to Experian, having a credit score of 750 or higher is considered “very good” and can impress potential lenders when you’re seeking a mortgage. The lower the credit score, the higher the mortgage rate you will likely pay.
- Figure out your budget. Before you meet with a lender, determine how much house you can afford and how much you feel comfortable paying. These numbers might not be the same. A good rule of thumb is to have your total housing payment, which includes mortgage, insurance, and fees, be no more than 35% of your pre-taxed income.
- Determine how much you can contribute for a down payment. Most mortgage lenders require you to put down at least 10% unless you’re obtaining an FHA or special program loan. If you have more money to spare, consider putting at least 20% so you avoid paying private mortgage insurance (PMI).
After you complete all these steps, you need to explore your mortgage options. The main mortgage types include the following:
- Conventional Loan. Although they’re not guaranteed by the government, conventional mortgages require as little as 3% down.
- Adjustable-Rate Mortgage (ARM). These have variable interest rates, and the rate adjusts at a predetermined timeframe, anywhere from one month to ten years.
- Interest-Only Loans. These loans require you to pay only the interest on your mortgage for a set time, usually five to ten years, and then you pay both interest and principal.
- Bridge Loans. These bridge loans are ideal if you have a loan on your current home and are looking to move to a new one.
- Government Loans. Some of the loans that fall under this category include FHA loans, which allow down payments as low as 3.5%; USDA loans for rural homebuyers require no down payment; and VA loans are for current or veteran military service members and their families and typically require no down payment.
Knowing which type of loan works best for your needs and budget is important, especially if you want to secure the best rates possible. Make sure you fulfill the requirements, and then you can make an offer on the house of your dreams.
If you’re interested in obtaining more information about first liens, reach out to the professionals at Titan Funding. We offer loans that aren’t usually available at commercial banks, mortgage companies, or other traditional lenders. Reach out to us today so we can get you started on your financial journey.