Typically, a second mortgage is defined as a secured loan that is subordinate to a first mortgage on the same property. The borrower can generally use the proceeds from a second mortgage for any purpose. Currently, a popular use of second mortgages is to pay off high-interest consumer debt, such as credit cards and car loans. Other common uses are for home improvements, college tuition, or to take a vacation. Second mortgages can even be used to secure lines of credit for future needs.
In the past, the total amount of debt from a first and second mortgage combined could not be more than 80% of the home’s appraised value. Recently however, low interest rates and a hyper-competitive marketplace created a lending environment where some lenders were approving second mortgages that, when combined with the first mortgage balance, totaled as high as 125% of the home’s appraised 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%.
A second mortgage is always subordinate to the first mortgage. This means that in the event of a default, the property is sold and the proceeds are used to pay the first mortgage first, including any legal costs and other costs of the sale. The remaining proceeds are applied to the second mortgage. If there is not enough money remaining from the sale of the home, the second mortgage does not get paid.
A Higher Interest Rate
The interest rate that a lender is willing to loan money out at for a home mortgage is dependent on the risk level to him. For this reason that a high risk borrower with a poor credit history will always be charged a higher interest rate than 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.
2nd Mortgage Terms
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.
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.
Second Mortgages Types
Not only can the length of the second mortgage vary, so can other repayment terms. The majority of second mortgages, however, 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.
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 mortgage, do your homework and shop around to ensure that you get the best deal for you!