A second mortgage is a loan that you take against the
equity that you have already built into your home. The proceeds from
the second mortgage can generally be used for whatever purpose the borrower
has in mind. It can be used to pay off a car loan or credit cards. The
proceeds can be used for home improvement or to take a vacation. The
money can even be put in a savings account for a rainy day fund.
What to consider when
securing a Second Mortgage.
Historically the total amount of debt from the first and second
mortgage combined could not be more than 80% of the total market
value of the home. However, low interest rates and a
competitive marketplace have created a lending environment where
some lenders are approving second mortgages that, when combined
with first mortgage balance, is totaling as high as 125% of the
home value.
However, financial advisors will tell you that carrying that
much debt on your home is never a good idea. I never recommend
borrowing more than 100% of the value of your home and I rarely
recommend a second mortgage with a loan to value of greater than
90%.
Because a second mortgage is a property lien that is placed behind
the first mortgage, this means that in the event of a default,
after the property is sold the first mortgage gets paid first,
including any legal costs and other costs of the sale, before
the second mortgage can be paid. If there is not enough money
from the sale of the home, the second mortgage does not get paid.
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A second mortgage attracts a higher interest rate.
When determining the interest rate that a lender is willing to loan money
out for a home mortgage, he looks at the risk level to him for loaning
that money. This is the reason that a high risk borrower with a
poor credit history gets charged a higher interest rate than a low risk
borrower with a strong credit history.
The same theory holds true with a second mortgage. Because the lender
of the second mortgage is second to be paid off in the event of a default,
and because there is a greater chance that there might not be enough equity
in the home to pay off the second mortgage in full, second mortgages are
usually given at a higher interest rate than are first mortgages; irregardless
of who the borrower is.
Terms of a Second Mortage.
Although you will have choices for terms when selecting your second mortgage,
in general the terms given for them are shorter than those of a first
mortgage. This is primarily because the amount of the second mortgage
is generally much lower than that of the first mortgage.
Second mortgage repayment terms can vary considerably, so it is important
that you look around for the one that is best for you. For the most
part they range in length from 5 to 20 years, with the majority of second
mortgage loans being 10 to 15 years. A select number of lenders
will offer a 30 year amortization and some of them will balloon (set
a maturity date) of 15 years. This loan is called a 30 due in 15. Generally,
just like first mortgages, the longer the maturity, the higher the interest
rates. Also, just like first mortgages, the higher the credit
score (FICO) the lower the interest rate.
Just as the length of the second mortgage can vary, so can other repayment
terms. The majority of second mortgages are paid back in equal monthly
payments with a portion of the payment going to interest and a portion
to the principal balance, just like a first mortgage.
Types of Second Mortgages
The two most common types of second mortgages are the fixed rate and the
HELOC (home equity line of credit). The former is a standard offering.
The HELOC is a little unique and has been very popular. The loan
typically calls for interest only payments for the first 5 to 10 years
and then the line of credit is frozen at the outstanding balance of the
loan. At that point, the loan payments are recast and a standard
principal and interest payment is established for the remaining 10 to
20 years. The HELOC's are typically priced with a variable interest
rate that is most commonly indexed to the New York City prime interest
rate.
Pricing on the HELOC's is like other loan pricing; the lower the FICO
score and the higher the loan to value, the higher the interest rate.
When considering a second home mortgage, be sure to shop around and
then talk to lenders to ensure that you get the best deal for you!
