What Is a First Mortgage?

How does a first mortgage work?

A first mortgage is the initial loan a buyer takes to purchase a property. The loan is in the first position, meaning that if the borrower defaults, the bank forecloses on the property and the first mortgage is paid off before the proceeds from the sale are used for anything else.

Typically, a down payment is required, and the loan covers the rest of the purchase price. The amount of down payment required depends on what type of mortgage you get. For example, a conventional loan requires at least 3% down, while a VA loan doesn't require a down payment.

Monthly payments are typically required over a long period of time, usually 15 or 30 years. Each monthly payment covers any accrued interest for that month, and the remainder of the payment is used to pay down the principal of the loan.

If the property is refinanced, the first mortgage is paid off by the new loan. Borrowers may refinance to get a lower interest rate or to extend the length of the loan, thereby reducing the monthly payment.

First mortgage requirements

Different types of loans have different requirements for credit scores and down payments.

Carl Holman, director of marketing at Foundation Mortgage, explained: “For a first mortgage, eligibility is determined by more than just a credit score. We look at the whole borrower profile, including income documentation flexibility, assets and property type.” Holman told us this approach allows borrowers who can repay but don’t meet conventional requirements to buy a home.

The higher your credit score, the more likely you are to be approved, and with better terms. Someone with a credit score of 620 may get approved for a conventional loan, but they are unlikely to qualify for the best rates.

While the minimum down payment requirements are small, you’ll likely owe mortgage insurance if you put down less than 20%. Private mortgage insurance typically costs between 0.5% and 1.5% of the loan amount per year.

Also, the lower your DTI ratios, the more likely you are to get approved. A 45% DTI ratio means that 45% of your income is being used to make the minimum payments on your debts. The lower this ratio, the better loan terms you will qualify for. For example, you may qualify for a larger loan or better interest rates with a lower DTI ratio.

Each type of loan also has a maximum amount you can borrow. For single-family homes in the contiguous U.S., the limits are as follows:

• Conventional loans: $806,500

• FHA loans: $524,225

• VA loans: $806,500

• USDA loans: $419,300

Most loan programs set higher limits for homes in expensive areas, and jumbo loans are available for properties priced above those limits.

» MORE: Help for first-time homebuyers

First mortgage and loan-to-value (LTV)

The loan-to-value (LTV) ratio is the amount of the market value of the property compared to the loan amount. For example, a $500,000 property with a $400,000 mortgage has an 80% LTV.

Making a large down payment will lower your loan-to-value, making you a more favorable borrower. Lenders use this ratio to help decide how much you can borrow and at what interest rate.

Lending companies also use it to help determine if you need to pay private mortgage insurance (PMI). If you have a loan-to-value of greater than 80%, you will likely be required to carry PMI.

Holman said: “Typically, the lower the LTV, the stronger the borrower’s equity position, which can translate to more favorable interest rates. That said, we also take into account the overall risk profile of the loan, credit history, income verification and property type — all factor into the final rate.”

First mortgage vs. second mortgage

A first mortgage is used to buy a property, while a second mortgage is a loan taken out against the equity of the property and can be used for any purpose. Popular uses for second mortgages, which include home equity loans and HELOCs, are home improvement, debt consolidation, making large purchases or covering financial emergencies. These loans do not replace any existing first mortgage; they sit in second lien position and follow their own repayment structure.

The property secures both loans, but the second mortgage is in the second lien position. This means that if the property is foreclosed, the first mortgage is paid in full first, and any leftover funds from the sale are used to pay off the second mortgage. In the event that foreclosure proceeds do not cover both loans in full, the second-mortgage lender may only receive partial or no payment at all.

Because being in the second position carries more risk for the lender, the interest rates on second mortgages tend to be higher than on first mortgages. The main risk for borrowers is losing the property through foreclosure if they default.

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