A second mortgage typically refers to a secured loan that is subordinate to another loan against the same property. Proceeds from a second mortgage can generally be used by the borrower for any purpose. Often proceeds from second mortgages are used to pay off consumer debt, such as credit cards or car loans. Proceeds can also be used for home improvements, college tuition, or to take a vacation. Some borrowers use second mortgages to secure lines of credit for future needs.
Until a few years ago, the total amount of debt from the 1st and 2nd mortgages combined could exceed 80% of the total market value of the home. Recently however, low interest rates combined with a competitive marketplace have created a lending environment where some lenders have approved 2nd mortgages that, when combined with the balance due on the 1st mortgage, total as high as 125% of the home value.
Most financial advisors will warn you that carrying that much debt on your home is never a good idea. In my practice, I never recommend borrowing more than 100% of the value of your home and would 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.
Why A Higher Interest Rate?
Before a lender is willing to loan money out for a home mortgage, he looks at the risk level to him to determine the interest rate to charge. That is why a high risk borrower with a poor credit history gets charged a higher interest rate compared to a low risk borrower with a strong credit history.
The same theory also applies to second mortgages. Second mortgages typically are given a higher interest rate, because by definition a lender of a second mortgage is second to be paid off in case of a default, and because there is a greater chance that a default might result in not enough equity left in the home to pay off the second mortgage in full.
Second Mortgage Terms
Even though you may be offered several options for terms for your second mortgage, the terms offered will most likely be shorter than those of a first mortgage. This is primarily due to the fact that the amount of the second mortgage is generally much lower than that of the first mortgage.
Repayment terms for second mortgages can vary considerably, so it is important to look around for the one that is best for you. Mostly they range in length from 5 to 20 years, with the majority of the loans being 10 to 15 years. Some lenders may offer a 30 year amortization with a balloon (maturity date) of 15 years. This type of loan is referred to as 30 due in 15. Generally, the longer the maturity, the higher the interest rate. Conversley, the higher the credit score, the lower the interest rate.
Types of 2nd Mortgages
Just as the length of the second mortgage can vary, so can other repayment terms. However, 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.
The two most common types of second mortgages are the fixed rate and HELOC (home equity line of credit). The fixed rate mortgage is a standard offering. The HELOC is a little unique and has been very popular. This loan type 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. HELOC’s are typically priced with a variable interest rate.
As with other loan pricing, the lower the FICO score and the higher the loan to value, the higher the interest rate for HELOC type mortgages.
When considering a second mortgage, do your homework and shop around to ensure that you get the best deal for you!
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