Evaluating the Second Mortgage Option
If you find yourself in a financial situation in which you need money, it’s possible that a second mortgage will provide you with a good way to get that money. Second mortgages are used for various purposes though there are some advantages and disadvantages that should be considered before taking out a second mortgage.
What is a Second Mortgage?
A second mortgage is just another mortgage on your home, with the home serving as the security (collateral) for the loan, just as with the first mortgage.
A second mortgage loan is given the label “second” because your home’s first mortgage retains top priority for repayment. In other words, the first mortgage must be paid off before any money goes to pay off the second mortgage.
Who Uses a Second Mortgage?
The second mortgage is often used by homeowners who need a substantial amount of money and who have significant equity in their home. Lenders generally consider loans against a home to be a good risk and thus larger loans are often secured through a second mortgage.
Second mortgages are often acquired for such reasons as completing home improvements (e.g., a large remodeling project), buying a second home, or consolidating debt.
Some homeowners secure a second mortgage in order to avoid the need to buy Private Mortgage Insurance (PMI). The second mortgage may also be used to secure a Home Equity Line of Credit (HELOC).
While it may be tempting to take out a second mortgage to get money, homeowners should weigh the benefits carefully and remember they are borrowing against their home. That said, if it is the only way to pay for an important need, and running up credit card balances is an unattractive option, then a second mortgage may be the best way to generate funds.
Drawbacks of Second Mortgages
The main disadvantage of a second mortgage compared to some other type of loan is that you are risking your home in the case that you default on the loan. For this reason borrowers need to make sure that they have a very important need for the money they are borrowing before taking out a second mortgage.
Another disadvantage of a second mortgage is that the interest rate is typically higher than the rate on the first mortgage, which is also called the primary or senior mortgage. The higher interest rate on a second mortgage is due to its secondary position and thus increased risk compared to the first mortgage. Still the interest rate will likely be lower than alternatives such as credit cards.
A third potential drawback of a second mortgage is the second mortgage fees that will likely be required. A careful consideration of how much money you need and how long you will need it will help you determine if the fees charged for a second mortgage make financial sense for your particular situation.
Finding a Lender for Your Second Mortgage
Many lenders offer second mortgages so it pays to shop around for the best terms and conditions. A good place to start is an institution you are already familiar with like your credit union or bank. Some borrowers may be able to save some costs in fees by securing a second mortgage through the same company that holds their primary mortgage.
If you want to cover all the bases in ensuring you get a good deal on a second mortgage then make sure to contact at least one credit union, one bank and one dedicated mortgage lender.
Things To Look Out For When Getting a Second Mortgage
Find out all the details of what is offered and try to avoid second mortgages that include default penalties when a payment is missed or late. This could cause a steep increase in your interest rate, and though you may be very diligent about payments you never know when a mistake might occur leading to the default penalty taking effect.
Another thing to avoid in second mortgages is a large prepayment penalty. Avoid locking yourself in to a long-term second mortgage when your financial conditions may change and you may wish to repay the loan to avoid the continued costs in interest.
Find out all the details of any potential second mortgage and read the fine print closely. What are the application costs (which may be non-refundable if you are denied), up-front costs for processing the mortgage, title search costs, appraisal fees and closing costs. Ask for a printed list of all fees when you are inquiring about a second mortgage.
Borrowers will generally want to avoid second mortgages that are bundled with insurance policies that are voluntary and which may not be needed. Some insurance coverage may be needed but you may already have it outside of the second mortgage. Evaluate any insurance needs and policies separately from the second mortgage itself.
Beware of offers that seem too good to be true as there is probably a reason for this that shows up in the fine print. For example, be very careful about accepting any balloon payment arrangements that begin with low and affordable monthly payments and then require a huge payment at the end.
This payment schedule may be offered to make the second mortgage attractive to borrowers but can lead to big problems in the long run when a large amount of money comes due.
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