The house covers both of you only if the house sells for what you think it's worth, and in a foreclosure it usually doesn't. That's where the extra 3 percent goes.
Lien position means order of payment. The first lien lender gets paid in full out of sale proceeds before the second lien lender gets a dollar. So take your example: 78 combined LTV on a house you value at 400,000 means about 260,000 to the first and about 52,000 to you. If the property sells at a foreclosure auction for 300,000, which is not an unusual outcome once you account for a distressed sale, deferred repairs and no marketing period, the first is paid and there's 40,000 left before costs. Add accrued interest, unpaid property taxes, the first lender's legal fees and the receiver, and your 52,000 can go to zero while the first lender is made whole. Your loss isn't proportional to the value drop, it takes the whole hit after the first is satisfied.
Control matters too. The first lien holder generally drives the foreclosure and the timing, and a junior lienholder's practical options are to pay off the senior loan to protect the position or to bid at the sale, both of which require cash you may not have set aside. Junior lien rights and how a foreclosure wipes them out vary by state, so confirm the specifics where the property sits.
One thing to look for in any second position offer: whether there's an intercreditor or standstill agreement with the first lender, and whether the first lender even knows about your loan. Many first mortgages contain a clause making additional financing a default, which means your borrower may be in breach of his senior loan the moment you record.
