Second Mortgage

How to make the best out of second mortgage?

A second mortgage is obtaining another loan on the same property that is having an original mortgage. Normally, the second mortgage is taken to raise cash or for home repairs/extension. This second mortgage is considered to be subordinate to the first mortgage. That is, the lender that is having the first mortgage would have the first right for foreclosure and pay off, in case there is default on the first mortgage. As such, the lender providing the second mortgage faces a higher risk and would normally charge a higher rate of interest. Further, lenders would consider the sanction of second mortgage only if the credit rating of the borrower is very good because of the risks involved in second mortgage.

In several cases, the first mortgage amount would be lesser than the value of the property. Let us say the property value is $120,000 and the mortgage loan is $100,000. The difference of $20,000 is called home equity. This home equity could be utilized by resorting to a second mortgage for $20,000. The cash obtained through this could be used to clear or reduce credit card payments. This is because the credit card debts carry a high rate of interest in the range of 24% to 36% per annum and the second mortgage interest rate is comparatively much lower, usually in the range of 6% to 8% per annum or at the maximum, around 10% per annum.

Otherwise, the cash could be utilized to meet emergency or unforeseen expenses like medical expenses or educational expenses of children. Further, this amount could also be used to repair, modify, or extend the present home. One main advantage in mortgage loans is that they have certain tax benefits that other loans like personal loans, credit card loans, etc., do not have.

However, like the first mortgage loan, you would have to consider all the alternatives like the second mortgage loan amount, interest rate, period of repayment, other related costs, etc. Since you are already having a first mortgage, you are committed to repay a specific amount at present. You have to decide whether you would be able to pay this additional repayment amount also every month, without any financial burden. Planning your total monthly repayments carefully, by considering your current and future income, is very important to avoid payment default in future.

One another wise option is to take a second mortgage loan for the full value of the property and pay off the first mortgage. This could be done if you are able to get the second mortgage for adjustable interest rate, while the first mortgage is with a fixed interest rate. For example, the first mortgage might be at 8% fixed interest rate and the second mortgage home equity loan might be at 5.75% adjustable interest rate. This advantage in the interest rate could be utilized and the first mortgage fully cleared. In this case, the second mortgage would then become the first mortgage.

Second mortgage could also be considered when the loan amount is more that $240,000. This is because the two government agencies Fannie Mae and Freddie Mac consider loans that are larger than $240,000 as ‘jumbo’ loans. They charge a higher interest rate of ¼% or ½% for such loans. In such a situation, if you require a loan of $300,000, it would be better to take a first mortgage for $240,000 and a second mortgage for $60,000. You would be able to save considerably on the interest payment by splitting the mortgage as above.

If you already have both first mortgage and second mortgage loans, then it would be advisable to opt for refinancing for a fresh mortgage for the total amount of the two loans. This would convert the two loans into one. However, while doing this, you have to consider the terms of both the existing mortgages and the new mortgage being considered.

Further, if the property had appreciated in value over the years, either the first mortgage or both the mortgages could be refinanced without payment of mortgage insurance, depending on the extent of appreciation. These options might be somewhat confusing to an average person and it might be difficult to understand the various alternatives that are provided by mortgage calculators. In such situations, it would be advisable to consult a professional mortgage advisor like a real estate agent or a trained financial analyst to arrive at a right decision.

To sum up, advantages and disadvantages in second mortgage are provided below.

Advantages

• Home equity is fully utilized
• Loans with higher interest rates cleared
• Appreciation in property value is beneficially used

Disadvantages

• Second mortgage terms are normally higher
• Unless your credit rating is very good, lenders would refuse second mortgage
• Mortgage insurance payment might be significant, negating the advantages of second mortgage