How to Understand Second Mortgages

There is not a great deal of difference between first and second mortgages except that one is usually taken out when a home is bought, and the other is taken out on the remaining balance of the first mortgage.

Usually, homeowners will take out a second mortgage to undertake some renovations or improvements to the property, but increasingly, people are using the equity in their homes to reduce or eliminate their high rate credit card debt.

If you are improving your home to such an extent that it will substantially increase the value of the property, a second mortgage is probably a worthwhile decision. Certain home improvements are said to be especially helpful in increasing the value of a home, such as an additional bedroom or an upgraded kitchen.

Some home improvements, however, are nothing more than luxuries and will not affect the future value. An in ground pool is an example that is frequently mentioned, since there are many buyers (with young children, for instance) who would not care to have one.

Paying off expensive interest rate debt is probably a better way to use lower rate second mortgages, since you will save a lot of money over time. Typically the interest rate on credit cards can be 16 to 20% or more, whereas a second mortgage can be obtained at 5-9%, representing a substantial overall savings to the homeowner.

Creating more debt that is not going to either add value to your home, or reduce your currently outstanding debt is not a good economic decision.

Unlike a first mortgage, a second mortgage will not have priority on your home if you default. The first mortgage on your home would be repaid by your home’s value before any money goes toward the second mortgage.

Therefore, second mortgages will have a higher interest rate than first mortgages. The bank granting the second mortgage has a higher risk that the loan will not be paid, and increased risk is one of the most important determinants of interest rates.

There are closing costs with second mortgages just as there are with first mortgages. Make sure you are fully aware of all of the closing costs associated with the loan, so that you can be sure the total cost of the loan balances the increased value of the home or the savings on the credit cards!

Rates on second mortgages can vary a great deal, so it really pays to shop around, not only for the base rate, but also for the lowest package of closing costs. Since the loan amount of a second mortgage is typically not as much as a first mortgage, small differences in rates and costs can have a proportionately higher effect on the cost of the loan.

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