How Does a Second Mortgage Work?

For those who are only familiar with the usual first mortgage, you might be wondering what a second mortgage consists of? In simple terms, this is another loan that is secured against your home – using the home as collateral of the debt is unpaid. The term “second” refers to the fact that this loan has no priority over the first mortgage. Any mortgage will require the bank to place a lien on your home, this gives them the authority to “repossess” the property if you default on the account.

What this means is that the first mortgage will get paid accordingly in the case of default, and any leftover proceeds will go to the second mortgage holder. Second mortgages often come with a much higher interest rate because of the inherent higher risk of the loan.

This may be a viable option if you’ve already accumulated a substantial amount of equity in your home. To illustrate, if the value of your home is $150,000 and you now have only an $80,000 balance in the repayment of your original loan, then you have equity of $70,000. The amount that would be given to you as a second mortgage loan would be based on your equity position.

Benefits

For homeowners in need of extra cash, a second mortgage may be the answer. These mortgages often are described with various names, such as the common home equity line of credit (HELOC).

One advantage of a second mortgage is that the interest rates are typically lower compared to those charged for other kinds of loans such as credit card debt or a personal loan. The interest you pay for the second mortgage may also be tax deductible (check with your accountant) as with your first mortgage.

A second mortgage may have various purposes, including the funding of home improvements, emergency expenses such as medical bills, tuition fees, or debt consolidation. However, an alternative to consider is to refinance your home and to borrow the money that is in excess of the loan balance.

Different Types of Second Mortgages

Home equity loans: A home equity loan (your basic second mortgage) is a lump sum of money you may receive based on the amount of equity you have acquired. Your income, credit, and overall financial situation will be carefully examined to determine if you qualify for the loan – almost as if you were “repurchasing” the home. The amount will need to be repaid in installments over a set period of time.

Home equity lines of credit (HELOC): A HELOC functions very similar to that of a credit card. The lender will provide you with a specific credit limit based off the amount of equity and lending standards of the institution. For homeowners who need continuous access to credit for day-to-day uses, a HELOC may be the better option. The allowable loan amount is restored as the borrower repays the loan. However, like the credit card, you should be on the lookout for any penalties and you should negotiate with the lender for a lifetime cap on interest rates. You may also want to have the option of transforming your HELOC into a fixed rate loan.

Drawbacks

The main disadvantage with another mortgage is the fact you are risking your home if you are unable to make payments on the account. If you endure a financial hardship and can longer make payments, a second mortgage can be devastating. Be wise and evaluate whether or not the potential use of funds is worth the risk.

Another con is the fact that they will almost always come with higher interest rates than a first mortgage. This loan is considered a high risk for lenders and therefore will come with higher interest rates. Along with high interest, second mortgage often will carry substantial fees to obtain the loan. The fees alone can be the determining factor when deciding whether or not you can truly afford to take on this new debt.

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2 Comments

  1. I have two property (houses). One is pay off and my parents are living in there now. We make payment on the one we leave now. This week (OCT 16 to 20) we will go to NACA program over San Francisco. We don’t know that we able to get this NACA program. Do you have any ideas? My parents are making utility/water bills and no house payment since the house is pay off. What do we need to show NACA counselor? Is it ok for NACA to approve? I appreciate your help.

    Regards,

    Louis

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  2. I agree that a home refinance can be a safer bet than a 2nd Mortgage loan. It can take more time and you won’t get as much out of refinance but it should be the first option to look into.

      (Quote)  (Reply)

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