What Is a First Mortgage?
A first mortgage is a primary lien on a property. As a primary loan that pays for the property, the loan has priority over all other liens or claims on a property in the event of default. A first mortgage is not the mortgage on a borrower’s first home; it is the original mortgage taken on any one property. It is also called First Lien. If the home is refinanced, the refinanced mortgage assumes the first mortgage position.
- A first mortgage is a primary lien on the property that secures the mortgage.
- The second mortgage is money borrowed against home equity to fund other projects and expenditures.
- If the loan-to-value (LTV) ratio of a first mortgage is greater than 80%, lenders generally require private mortgage insurance.
- The mortgage interest paid on a first mortgage is tax-deductible, only applicable to taxpayers that itemize expenses on their tax returns.
Understanding First Mortgages
When an individual wants to buy a property, they may decide to finance the purchase with a loan from a lending institution. The lender expects the home loan or mortgage to be repaid in monthly installments, which include a portion of the principal and interest payments. The lender will have a lien on the property since the loan is secured by the home. This mortgage taken out by a homebuyer to purchase the home is known as the first mortgage.
The first mortgage is the original loan taken out on a property. The homebuyer could have multiple properties in their name; however, it is the original mortgages taken out to secure each of the properties that constitute the first mortgage. For example, if a property owner takes out a mortgage for each of their three homes, each of the three mortgages is the first mortgage.
The term "first mortgage" leads one to understand that there could be other mortgages on a property. A homeowner could take out another mortgage, such as a second mortgage, while the original and first mortgage is still in effect.
The second mortgage is money borrowed against home equity to fund other projects and expenditures. However, the second mortgage and any other subsequent mortgages taken out on the same property are subordinate to the first mortgage. This means that the first mortgage is paid before the secondary mortgages are paid in the event of default.
First Mortage and Loan-to-Value (LTV)
If the loan-to-value (LTV) ratio of a first mortgage is greater than 80%, lenders generally require private mortgage insurance (PMI). In such a case, it can sometimes be economical for a borrower to limit the size of the first mortgage to 80% LTV and use secondary financing to borrow the remaining amount needed.
The economics of paying PMI versus using a second loan largely depends on the rate at which a borrower expects the value of their home to increase. PMI can be eliminated when the LTV of the first mortgage reaches 78%. However, a second lien, which typically carries a higher interest rate than a first mortgage, must be paid off. This is most likely done through refinancing of the first mortgage for an amount equal to the remaining balance of both the first and second mortgages.
Taxes on a First Mortgage
The mortgage interest paid on a first mortgage is tax-deductible. This means that homeowners can reduce their taxable income by the amount of interest that has been paid on the loan for the tax year. However, the mortgage interest tax deduction is only applicable to taxpayers that itemize expenses on their tax returns.
Example of a First Mortgage
For instance, if a homebuyer secures a $250,000 first mortgage on a home property and, after several years, obtains a second mortgage for $30,000 on the same property, the first mortgage is senior to the second mortgage.
The borrower defaults on his payments after he has already repaid $50,000 of the original loan amount, and his property is foreclosed and sold to cover the loan. If the proceeds from the sale of the property add up to $210,000, the first mortgage lender will receive the balance owed, which is $200,000.
The second mortgage lender will receive whatever is left, which in this case is $10,000. Because a first mortgage is a primary claim that takes precedence over secondary claims, second mortgages usually command higher interest rates than first mortgages.