Things to Consider When Taking Out a Second Mortgage

Joseph Meyer
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What Is a Second Mortgage?

A second mortgage is a loan that is secured to the collateral of the primary loan and that is subordinated to the terms of the first mortgage. The second mortgage is paid off first if foreclosure takes place. A home equity loan, on the other hand, is a second mortgage in which a lump sum amount is drawn against the equity of the borrower’s home that is often secured by the equity in the home. As the name implies, home equity debt can be taken out at anytime, even after default has occurred in a primary loan.

Mortgage modification is a process that is usually accompanied by a second mortgage. In a traditional second mortgage, the payment gets added to the primary mortgage and is later paid off as a lump sum once the primary mortgage is taken care of. A second mortgage can be an alternative to home equity loans which could also be loaned out against the equity in the home. As an example, a second mortgage could be used to repay credit cards or other personal debt rather than drawing money against the equity in one’s home. The second mortgage usually comes into the picture when a borrower is unable to keep up with his or her mortgage payments, is behind on their mortgage payments, or is unable to pay their mortgage altogether.

How a Second Mortgage Works

Second mortgages are loans wherein a lender makes a secured loan, by using your real estate property as collateral. As the name suggests, you will be borrowing money, when you already have a first mortgage. If you want a better understanding about what a second mortgage is, here are some of the things you need to know:

How does a second mortgage work?

A second mortgage is when you take out a separate loan against the value of your property. In the case of a second mortgage, your lender can go after your second home if you fail to pay your loan. Second mortgages are typically unsecured and are considered to be more risky investments.

{1}. Second mortgages are for double the amount of debt of your first mortgage.
{2}. What are "points"?

Points or points-plus-origination fees is the money lenders ask from the borrower to show commitment to the repayment of the second mortgage. These include one-time charges but can possibly be added to your regular monthly mortgage payments.

What is a "balloon" payment?

A balloon payment is when the loan term ends after just a few years. This means you will need to pay off your entire mortgage in a balloon payment, usually on the due date.

What is a "piggyback" loan?

This type of second mortgage is designed to be paid at the same time as your first mortgage.

What are Second Mortgages Used For?

Second mortgages are becoming increasingly popular as a way to fund lifestyle remodels and income producing repairs. That’s because homeowners are able to combine the financial benefits of obtaining a second mortgage with the upfront convenience of a home equity loan or home equity line of credit. And, if you go through a lender like LendingClub, you’ll enjoy the superior underwriting criteria they employ, allowing you to achieve the lowest mortgage rates when you apply.

But even though a second mortgage is not hard to get, there are some important things you will need to carefully consider before you apply for one. And in this article, we’re going to cover:

  • Why do homeowners take out a second mortgage?
  • What are the benefits of second mortgages?
  • How do you compare the costs of home financing options?

As you read through this article, be sure to have your own situation in mind. If you’re hoping to finance a home remodel, then you will likely have a different set of goals, needs, and circumstances than someone who is trying to improve their cash flow through an investment property.

So, once you have read through this article and taken into account your own goals, needs, and circumstances, then you will have an effective way to start comparing all your different mortgage and lending options.

Getting a Second Mortgage

Second mortgages are a type of home equity loan, which is secured against the borrower’s current home. And for the sake of simplicity, the term mortgage would be used in this discussion to refer to both types of loans.

Nowadays, mortgaging yourself multiple times is a common practice. It is far more accepted now than it used to be back a decade ago when people used to get opinions about how important it is to own a house free and clear without any encumbrances. But what is it that you need to think about if you are considering getting a second mortgage? And how would this affect your other line of credit?

Here are two ways of approaching this situation which will help you reach an informed decision about whether to get a second mortgage or not.

Use a Good Lender

Second mortgages tend to be pretty expensive when compared to refinances for other purposes. Not only can lenders tack on extra fees, but they can also be pretty aggressive when it comes to assessing the value of your home and your ability to make the payments.

Look for a lender who can walk you through the loan application process step-by-step. Find out what will be required from you to get the loan and how much time you have to gather the information. It can’t be said enough:

“Beware of any lender that gives you a verbal estimate of a loan and demands a full application and all the documentation within 24 to 48 hours”.

If you’re not given time to get your financial records in order or if you’re rushed into a decision you’re uncomfortable with, find a new lender. Slow down, and make sure you’re comfortable with the information you’re being given.

Steps you Can Take to Get the Best Loan

A recent national survey revealed that most Americans choose their financial institutions based on convenience or familiarity, without giving a thought to whether their chosen institution is the best deal. If you’re like most folks, your home mortgage is only one of the financial products you use, yet you probably don’t give much thought to which financial institution you choose to run it.

While there are many ways you can get a mortgage, your main options will fall into one of two categories. You can choose a traditional bank or credit union, or you can choose an alternative lender, also known as a non-depository lender.

The advantages and disadvantages of using each type of lender differ. It is worthwhile to explore all the possibilities available to you and learn the ins and outs of cashing in on the best options.

Below are some of the factors you should take into consideration when looking for the best loan at the best interest rate.

Pros and Cons of a Second Mortgage

The difficulty in buying a home with a second mortgage is that they are an additional lien against the property. In other words, taking a second mortgage means that you have to pay off the first mortgage first before you can pay back the second.

Taking out a second mortgage to purchase a new property can be a good idea if the new property will likely appreciate faster than the value of your existing property.

However, it’s always important to take into account all the pro’s and con’s of a second mortgage.

Pros of a Second Mortgage

Since the advent of the FHA loan program in 1934, home ownership has steadily risen in the United States.[5] One of the main reasons we’ve been able to increase home ownership has been by increasing the pool of potential home buyers by making it easier to purchase a home with a mortgage.

The way we did this was by introducing second mortgages. Home equity loans, also known as second mortgages, allow you to borrow more than the value of your home.

With a second mortgage, you can borrow money for a remodel, cover current expenses, consolidate debt, or pay for unexpected home repairs. It also allows you to finance home improvements, such as new appliances, a new roof, or even a new swimming pool if you’re so inclined.

If you’re not able to take out a cash-out refinance and want more funds, your only other option is a second mortgage. Sometimes, you can get funds from a relative, but they want to be paid back. If you want to avoid handing out checks to your family, a second mortgage is your only option.

Home equity loans are also the only way to fund your home if you need money in the short term. If you need funds in the short term, a first mortgage loan is not a good option for you.

Cons of a Second Mortgage

A second mortgage, like any other borrowing, has its cons.

A second mortgage reduces the liquidity of your home.

This is a very important thing to consider before you even consider taking out a second mortgage for any reason. When you take out a second mortgage, you’re making it harder for yourself to sell your house if you ever have to do so. Short sales and foreclosures cause a better price in the long run.

A Second Mortgage Can Make It Harder for You to Sell Your Home

Short sales, foreclosures, and bankruptcies cause a better price in the long run.

Second mortgages can increase your monthly debt payment

A second mortgage can make your monthly mortgage payments much more expensive. The monthly payments will be negotiated based on the total amount that you borrow. If you’re taking out a second mortgage to pay off credit cards, you should expect to see a larger payment amount. If that amount is significantly higher, you might want to consider a debt consolidation loan that will keep your monthly payment the same.

Second mortgages may cause difficulty refinancing your home

Alternatives to a Second Mortgage

A second mortgage is a type of loan on top of your primary mortgage. In other words, a second mortgage is another loan that you’ll have to repay. And most likely, the interest rate you’ll pay on a second mortgage loan will be higher than that of your primary.

Banks aren’t the only places where you can get a second mortgage. Today, there are lots of lenders other than banks that provide these loans. Alternatives to second mortgages include credit unions, finance companies, brokers, and online lenders.

Before jumping the gun and taking out a second mortgage, consider alternative mortgage and financing options. Here are a few of the most common alternatives that you might want to consider:

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In general, the loan amount you can get for a second home is less than for your primary residence. If you’re planning to purchase a vacation home, how much you can borrow depends on whether you’re using the home as an investment property. If you’re buying a vacation home as a second home, which you intend to live in, you can borrow the full amount you need.

If you plan to use the vacation home for personal and investment purposes, such as renting it to make money while you use it yourself, you can typically borrow 85% to 90% of the purchase price.

If you already have a mortgage on your primary house, you can borrow a second mortgage on the vacation home. But it’s typically easier and cheaper to refinance the vacation home if you’re having difficulty paying your mortgage.

Second mortgages usually have a lower interest rate than a primary mortgage because the bank isn’t risking as much. The interest rate for second mortgages can also vary based on the term of the loan.

Other Alternatives

However, a second mortgage can prove helpful in various situations:

  • Get a home equity line of credit (HELOC) instead. HELOC is a loan taken out against the equity in your home and it can help your family in times of emergency. The interest rate is usually very low. You have to pay down the loan every month, and the interest rate goes down as the loan goes down.
  • Ask for a loan from family members. Many times, parents, grandparents or other relatives may be more than willing to help out, and you can avoid the high interest rates of a second mortgage.
  • Replace your car every so often. You may not always think of a car as a luxury, but it can be a costly one if you are paying interest on a vehicle slightly older than your current needs. Income limitations or other problems may prevent you from getting a loan for a new car to avoid the second mortgage interest rate, but if you have enough equity in your car, this may be an option for you.

Our Experience With a Second Mortgage

When we needed some money to get our house fixed up after buying it, we considered several options including a home equity loan.

As we considered the various choices, we were drawn to the idea of a second mortgage, also known as a home equity loan. A home equity loan or second mortgage is one that is taken out on a house to borrow money. Normally the mortgage is already in place.

When you take out a home equity loan, you commit to making payments for a few years. A home equity loan is structured much like a first mortgage. The only exception is that the rate of interest on a second loan is normally lower than the rate of interest on the first mortgage.

Why would anyone pay more interest on the first mortgage than they have to? Because they don’t use the whole second loan.

Instead, if they borrow all the money, they pay it off much quicker and save money in the long run. But, as we will explain in a minute, the moment they borrow the money, they are liable to pay the whole loan plus the interest.

That’s why, if we had known we would have to borrow the money, we still would probably choose a home equity loan. Of course paying the interest on a home equity loan is a lot easier than paying off a lot of mortgage debt.

Second Mortgages, Friend or Foe?

Unlike a first mortgage, the type of loan you get for your home, a second mortgage is like a second home equity loan.

First, some facts about taking out a second mortgage:

They are known to be a last resort used only by those who have exhausted traditional means.

They are secured by a lien on your home.

They are often a more direct charging mechanism based on the amount of equity in your home, even surpassing a first mortgage.

They are more secured than first mortgages because they have a higher priority against other creditors. This is because they aren’t subject to the claims of other creditors.

They have a shorter repayment cycle than first mortgages. This is because the money you have to borrow is usually a smaller amount.

Interest rates for second mortgages are usually higher than rates on first mortgages mainly because of the high cost to the lender.

If you’re considering taking out a second mortgage, you should do your homework first. Consider all of your alternatives. When comparing second mortgages to first mortgages, consider the type of interest rates and fees that each one offers as well as the times when you can make the payments. Ask lots of questions using each of the lender’s customer satisfaction surveys to get recent reports. This will give you information to help you make an informed decision if you do go ahead and take out a second mortgage.