First-rank mortgage (also first-rank, first-lien or senior debt) refers to the most secure available form of loan security. Senior debt takes priority over other more “junior” debt (such as mezzanine debt or equity). In practice, this means that lenders of the first-rank mortgage will be the first in line to reclaim money from the sale of collateral in case the borrower defaults, while junior debt owners will only receive their share if there’s enough capital left. Explore other types of real estate debt seniority in the guide to investment types in real estate crowdfunding.
Understanding First-rank Mortgage
When an individual or company borrows money to buy a property the land, and the building will almost always be taken as collateral. The lender naturally expects that the borrower will pay back the money, but the borrower may get into financial trouble or for any other reason, takes up another loan on the property. For the lenders, the question arises, who gets paid first if there is more than one loan on the property?
The first-rank mortgage is a term used to describe the priority of which lenders get paid first in case a borrower defaults. The real estate used as collateral will be sold, and the money will first be distributed to the lender that holds the first-rank mortgage, then to the lenders with the second-rank debt and so on. Lenders therefore also require lower interest rate payments on first-rank mortgages, as it is more secure and the best possible guarantee for recovering funds in case a homeowner defaults.
The original loan on a property is typically the first-rank mortgage. Real estate investors can have multiple mortgages and multiple properties, with many different loans, but practically speaking the first loan on a property is usually also the first-rank mortgage.
First-rank Mortgage and Loan-to-Value (LTV)
Mortgage lenders use the Loan-to-Value (LTV) ratio to determine whether to approve borrowers for loans and how much the costs should be for borrowing funds based on the respective collateral. The ratio measures the debt amount versus the estimated value of the property, and if the ratio exceeds a certain limit the lender might require mortgage insurance.
On residential properties, the maximum possible loan-to-value ratio for first-rank mortgages is often limited to 80%, while first-rank mortgages on commercial real estate can be limited to 60%. This means a residential homeowner must put up 20% to avoid the more expensive second-rank debt.
As an investor in real estate debt, your risk will be tied closely to the Loan-to-Value LTV ratio. The lower the debt compared to the estimated value of the property, the more likely it is that you will recover funds in case a borrower defaults on the repayments.
The bottom line
First-rank mortgage is the most secure form of debt with real estate as collateral. The first-lien or senior debt holder will always be paid the first in case a borrower defaults, compared to lower priority security like second-rank debt. Homeowners and realtors usually get somewhere between 60% and 80% as a first-rank mortgage. It is typically always the original loan in a property that is considered the first-rank mortgage.