Second mortgages are new loans which are taken out after the first mortgage, which are secured by the same property. The amount eligible to be borrowed is based on the amount of equity remaining in the property. Second mortgage interest rates are usually higher than the first mortgage rates, due to the higher degree of risk to the lender. Here is an overview of the basic features of second mortgages.
- Types of Second Mortgages
- Why Take a Second Mortgage?
- Approval Requirements
- Second Mortgage Rates
- Facts About Second Mortgages
Types of Second Mortgages
There are three basic types of second mortgages:
- Fixed rate loans
- Adjustable or variable rate loans
- Home equity line of credit (HELOC)
Fixed-rate loans have a pre-determined interest rate and loan term. The rate remains the same over the life of the loan, which is typically between ten and twenty years. An example of a fixed-rate 2nd mortgage is a loan fixed at 8% for a term of 20 years.
Adjustable (variable) rate loans are a bit more complicated. They can have a fixed rate for short period of time, but then the rate will change periodically for the remainder of the loan term. Rate adjustments can move up or down based on a specific index, like the prime rate. The rate adjustments can occur only at pre-determined intervals, such as monthly, quarterly, or yearly.
Home equity line of credit (HELOC) is a revolving line of credit which is similar to a credit card, except that it is a credit line secured by your house or property. Like a credit card, it has a maximum credit limit and an expiration date. You may use any amount of the available funds whenever you choose, or keep the balance at zero and keep the credit line open for emergency use only. Your monthly payments will vary based on the average monthly balance due, just like a credit card. Once the credit term expires, you must either pay the outstanding balance in full, or else refinance second mortgage.
Why Take A Second Mortgage?
- Debt consolidation – People with large amounts of credit card debt can sometimes reduce their monthly payments by taking out a 2nd mortgage at a lower rate of interest, then use the proceeds to pay off their credit cards and close the accounts. As a result, they will have a single lower-interest payment to make each month, instead of many high-interest ones. Of course, this strategy only works if the credit card accounts get closed, or else the temptation to run up the balances again could cause you to wind up in a worse position than when you started.
- Tax Deductions – Home mortgage interest is normally tax deductible. Check with your tax adviser to be sure.
- Home Improvements – Since second mortgages are secured by your home, it can make sense to use the funds to make improvements that will increase the value of your home.
- Investments – You may wish to borrow funds against your house to invest in a business opportunity. Of course, this carries the risk of the business failing to make a profit.
- Avoiding PMI – To avoid private mortgage insurance (PMI), you need to provide at least a 20% down payment when buying a house. If you don’t have enough cash on hand, it is often cheaper to use a second mortgage to borrow enough to make up the difference and bring you total down payment to 20%.
- Eliminating PMI – If you already have PMI, you may be able to eliminate it by using a 2nd mortgage to pay down enough of your first mortgage balance to get it below the 80% threshold. Check with your lender for details.
- Major Life Expenses – College tuition and medical bills are large expenses that might occur when you don’t have enough cash on hand to pay in full. Often times, second mortgage rates are lower than interest rates on credit cards or student loans, and so can provide an attractive way to pay for major expenses. Many people keep a HELOC open at a zero balance, in case they need to use it for a sudden emergency.
Approval Requirements
Second mortgages are usually more difficult to obtain than first mortgages. When evaluating applications for second loans, lenders typically look for the following:
- Sufficient equity remaining in the property
- Low ratio of debt-to-income
- Excellent credit score
- Solid employment history or proof of income
Second Mortgage Rates
Interest rates on second mortgages are normally higher than the rate on first mortgages. This is because the loan is riskier for the lender. However, especially with variable-rate loans, you may be able to find attractive rates by shopping around. There is fierce competition amongst lenders in the mortgage market.
When looking for adjustable-rate (variable-rate) mortgages (ARMs), be sure to compare the following features:
- Fixed Period – How long is the initial period when the rate is fixed?
- Teaser Rates – Is the initial interest rate exceedingly low? How much will it increase?
- Adjustment Period – How often can the rate be changed? (yearly, quarterly, monthly)
- Adjustment Dates – Are there specific calendar dates that the rate adjusts on?
- Absolute Rate Caps – What is the maximum and minimum rates allowed over the life of the loan?
- Adjustment Caps – What is the maximum adjustment allowed in one period?
- Tracking Index – What index is used for determining rates? (prime rate, LIBOR, etc.)
Facts About Second Mortgages
- The lender for the first home mortgage (primary lender) takes precedence over the lender of the second mortgage (secondary lender), which is said to be in second position. In case of default, the primary lender is first in line to be paid in full, before the secondary lender receives anything.
- Second mortgages can be refinanced, just like firsts. When looking to refinance, second mortgage rates should be substantially lower than your current rate in order to justify the costs involved with getting a new loan.
- The process for obtaining a second mortgage is similar to that of a first mortgage. You must submit all of your personal and financial information in an application to the new lender before they can approve the loan. The second mortgage is an entirely new loan. As such, a new home appraisal will be required, and there will be other fees such as points, origination fees, and closing costs.
- Second mortgages are harder to obtain than first mortgages, because the approval requirements are more stringent due to the fact that the lender is in second position.
- Having a second mortgage means that there are two payments every month, not just one. Each loan must be paid separately, even if the lender is the same.
Go back to Aspendance Realty home to learn more about second mortgages.