Second Mortgage Guide
A second mortgage is simply another loan that uses your home as collateral. "Second" or 2nd refers to the order in which it must be paid off. You must pay off your first mortgage before your second mortgage. Since this makes a second mortgage riskier to lenders, second mortgages may have higher interest rates than first mortgages of the same loan type.
What Do Homeowners Use A Second Mortage For?
- Cash-Out Refinance — Homeowners can use the cash however they wish. A popular use is to pay for home improvements. Debt consolidation and paying for a child's education are also common. In some cases, homeowners with large amounts of equity may use the proceeds to help finance the purchase of second home or make other investments.
- Revolving Line of Credit — Disciplined homeowners can use a Home Equity Line of Credit (HELOC) similar to a credit card account based on the equity of their home. It can be used to finance regular purchases or as a source of cash in the event of an emergency.
Types Of Second Mortgages
- Home Equity Loan — These are similar to first mortgages. They can be either fixed or adjustable rate loans. 15 and 30 year terms are common. Some second mortgages start with lower initial payments, but end with large balloon payments. These are riskier since if you are not careful, when the balloon payment is due you may not have sufficient cash to pay it off and you may no longer qualify for a refinance.
- Home Equity Line of Credit (HELOC) — These are revolving accounts whose balance can vary over time. They are analagous to credit card accounts with a credit limit that is based on the equity you have in your home.
Why Get A Second Mortgage Instead Of Increasing The Amount Of Your First Mortgage?
- To Avoid Paying Mortgage Insurance — First mortgages may require Private Mortgage Insurance (PMI) while the principal balance of your first mortgage is greater than 80% of the value of your home. Private Mortgage Insurance payments represent insurance for your mortgage lender and do not get applied to your principal balance. A second mortgage may save you money by avoiding PMI.
- To Avoid Refinancing Your First Mortgage At A Higher Interest Rate — You may not qualify for an interest rate that is as low as the rate you currently have on your first mortgage. Financial market conditions, a decrease in the value of your home and changes in your credit or income can all be contributing factors. Getting a second mortgage may be less expensive than refinancing your first mortgage at a higher interest rate.
Who Do You Get Second Mortgages From?
Many of the same mortgage lenders who offer first mortgages also offer second mortgage loans. When a home buyer finances the purchase of a new home with a 1st and 2nd mortgage, it is not uncommon for both the first and second mortgages to be from the same lender. When a second mortgage is added later it is not unusual for it to be from a different lender.
What Are The Risks Of A Second Mortgage?
Borrowers should be cautious when considering increasing their mortgage debt. It poses real risks especially if home values decline. They should carefully consider whether any cash-out is truly in their best interests or whether they have the discipline to manage a HELOC responsibly. Borrowers should be careful to leave sufficient equity in their home to withstand significant housing price declines. A large percentage of homes that went underwater in the housing crisis had second mortgages. An underwater mortgage leaves you with no easy way out. Having a first and a second mortgage with two different lenders may make it much more difficult to get important changes approved, including:
- Refinance
- Loan Modification
- Short Sale