How Does a Second Mortgage Work?

For those who are only familiar with the usual home mortgage loan, they might be wondering what a second mortgage is. In simple terms, this is another loan that is secured against your home but it does not have the same priority as the first mortgage loan when it comes to getting the proceeds from the sale of your home in case of a foreclosure.

What this means is that the first mortgage will get paid first and if there is any money left over then it goes to the second mortgage holder. What this also means is that a second mortgage will have a higher interest rate because of the inherent higher risk of the loan.

A 2nd mortgage would be possible if you have 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 this value.

Why would a homeowner want to get a second mortgage when he is already gone a long way into paying the first mortgage?

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

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.

Refinancing may be a better alternative if interest rates are low or when they begin to decrease. However, the underwriting requirements for a second mortgage are less strict compared to refinancing and they usually require less time and effort to complete. Another factor is that the transaction expenses for a second mortgage may be lower so that in the long run, they may actually be less costly than refinancing.

However, make sure to check the interest rates because some lenders may try to encourage you to get a loan by offering low rates at the start but this could increase gradually to very high rates.

You may also want to take into account another kind of second mortgage loan, which is the home equity line of credit or HELOC. Instead of a one-time loan, the HELOC functions like a credit card in which the borrower may be able to borrow against it until he reaches a maximum amount. 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.

There are various options, so make sure to shop around for the best arrangement that you can have.

Tagged as: explain a 2nd mortgage, how do i get a second mortgage, How Does a Second Mortgage Work, what is a second mortgage