What Is a Junior Lien?

As a busy real estate professional, you should expect the unexpected when it comes to client questions. You’re the subject matter expert for your customers, and they depend on you to offer guidance and advice on a wide range of topics.

Many people have heard of a “second mortgage,” but they may not know that they’re also referred to as junior liens or junior mortgages and that the term also encompasses home equity loans, HELOCs, and piggyback mortgages

These products carry a certain amount of risk as well as higher interest rates. Junior liens are subordinate to the original mortgage as long as it’s still in effect, and if the borrower defaults, the first loan must be paid off before any secondary liens.

Consumers are facing a lot of challenges these days, and applying for a junior lien might seem like the best way to access much-needed capital for buying or renovating a home — but as with any complex financial decision, all angles should be considered carefully.

Here’s everything you need to know to educate your clients on the pros and cons of junior liens and ensure that you’re providing expert advice. 

Buyer Basics

Some hopeful homebuyers don’t quite have the cash reserves for a hefty down payment, but they’ve got exceptional credit (a score of 740 or higher), a low DTI, and are able to qualify for a conventional home loan. If their lender approves, they may want to take out two loans, with the first mortgage being for 80% of the home value, and the second for 10%, with the final 10% coming out of pocket. This piggyback mortgage is sometimes called an 80-10-10 loan.

This move was quite common before the housing bubble burst, and is now less widely used. The main benefit is that a piggyback mortgage simulates a 20% down payment, without the actual cost, resulting in a lower interest rate and no requirement for private mortgage insurance

Purchasing a house this way has some obvious benefits but it has some drawbacks as well. Financing in this fashion helps buyers avoid pricey PMI, and it can help those who need a jumbo loan that exceeds the Fannie Mae and Freddie Mac limits

And since they’re taking out two mortgages, your clients will have to pay double the closing costs. The interest rates on the second loan will be higher, which could be more expensive in the long run if it isn’t paid off quickly. If it’s in the form of a HELOC, the loan could have variable rates, which makes it a riskier choice for some borrowers.

If the Fed lowers interest rates next year, it may be more difficult to refinance this particular type of junior lien. Encourage your customers to consider every financing option as well as programs for first-time home buyers and down payment assistance.

Helping Homeowners

With limited inventory and rising demand, areas in the Upper Midwest like Wisconsin and Chicago are still enjoying a strong seller’s market as we head into spring 2023.

It’s an excellent time for those who want to sell their home and reap a tidy profit. But while there’s not an abundance of homes on the market, many buyers still expect upgrades like hardwood flooring, chef’s kitchens, and spa baths, and not every homeowner has the available funds for pre-listing renovations.  

Some motivated sellers will also get a pre-listing inspection and experience every homeowner’s worst nightmare — costly problems with the roof or foundation or serious issues with the electrical or plumbing. A junior lien in the form of a home equity loan could save the day, allow your client to make the required repairs or updates, and receive the maximum asking price for their property.

Tapping into their home’s existing equity for fast cash might be the right move in their current situation, but be sure to remind your client to carefully evaluate their finances before making a final decision. If the loan is indeed for home improvements, they should consult with their real estate team to help ensure they’re making choices with the biggest ROI.

While home equity loans generally have lower interest rates, it’s still a hefty additional payment that needs to be made each month. If something happens and the borrower misses payments or defaults, they’re in danger of losing their home. 

There’s also a chance that property values will drop and your client could end up underwater. It’s crucial for anyone in that position to talk to their lender, remain calm, and keep making their payments on schedule. 

The Value of a Team

Delivering a stellar customer experience for your clients is paramount in this industry, and being able to offer expert real estate advice or a top-level referral to a colleague in your network ensures you’re always the go-to resource.

The Chicagoland and Wisconsin housing markets are hot right now, as our population becomes more mobile and remote workers flock to regions with a lower cost of living. Brokers continuously encounter a wide range of client needs, so it pays to do your due diligence when it comes to financing options like junior liens, piggyback loans, and second mortgages.

Landtrust provides an array of services to agents, lenders, real estate attorneys, and commercial investors. Reach out today to see how we can help you scale your business sustainably.

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