A third mortgage is a risky bet for a lender who isn't entirely convinced you'll honor your commitment to repay it. In the event you fall upon hard times and seek bankruptcy relief, the lender for a third mortgage doesn't get paid until after the first and second mortgage holders are satisfied. As a result, you're unlikely to qualify for one unless you have enough equity in the property that the lender can be assured the loan doesn't carry excessive risk.
Third mortgages are subordinate to the existing liens on the property, which means the lender takes on a greater risk if you become unable to afford the loan and your property declines in value. Generally, interest rates are higher to compensate for the lender risk. For example, if you declare Chapter 13 bankruptcy, the bankruptcy court may strip the lien from the property and convert it to unsecured debt if your home is worth less than the balance of your primary and second mortgages. If that occurs, the lender likely will see very little of the amount returned during the course of the bankruptcy proceedings.
Lenders of third mortgages focus on loan-to-value ratio in addition to looking at your credit history and income. The more equity you have in the property, the better your chances of qualifying. Lenders are unlikely to approve a loan that exceeds their specified LTV ratio, which often is between 80 and 90 percent, and you'll need a strong credit score and stable income to gain loan approval. You're also likely to have better luck at smaller, local banks and credit unions than you are with major lenders.
Lenders may ask the purpose of the third mortgage loan as another way of assessing their risk. If the loan is for debt consolidation, for example, it may be viewed differently than if you're maxing out on your equity to go on a world cruise.
You're often more likely to receive a third mortgage from the lender that already holds your second mortgage. Your primary lender also may be willing to provide a home equity loan, but on the condition that the loan pays off the secondary lienholder. In some cases, a recent property tax bill will be enough to determine the value, but often the home will need to be appraised to determine how much equity you have.
Pros and Cons
Third mortgages aren't particularly common, because often lenders will suggest a refinance of the existing loans or a cash-out mortgage for homeowners who find themselves with sufficient equity in the property. Your options for lenders are more limited than other loan products, and the interest rates are higher than you'd pay if you refinanced your property and folded everything into one primary mortgage loan.
In certain situations, however, third mortgages may make more sense. If you have primary and secondary mortgage with low rates, for example, a refinance may cause you to have to pay more interest and therefore increase your payments. This is particularly true if you have a lot of equity in the home but your credit score has dipped over time. If you have $150,000 in first and second mortgage loans on a property worth $500,000, and you secured the loans when rates were low and you had excellent credit, a third mortgage may make sense if you're looking to pull out another few thousand dollars to bolster your checking account. Similarly, if either or both loans have large prepayment penalties, it may not be worth it to your bottom line to refinance them.