How To Understand Second Mortgages
The difference between a first and second mortgage is simple
. A first mortgage is taken out for the purchase of the home, while a second mortgage is taken out on any residual value between the outstanding mortgage balance and the value of the house.
Second mortgages are usually obtained to perform some substantial improvement to the home, but frequently homeowners decide to use the increased equity in their property to take out a second mortgage and pay down consumer debt.
The only time it really makes sense to take out a second mortgage for home improvement is if the improvement is going to add to the value of the home. There are some projects that are considered more valuable in the eyes of homebuyers, such as extra bedrooms or a renovated ktchen, that will make them willing to pay more for the home.
Taking out a second mortgage to install an in ground pool may not be the best use for the funds, since a luxury item like this may not necessarily add to the value of a home.
Many credit advisors recommend using a second mortgage to those consumers who are paying high interest rates on consumer debt. Typically the interest rate on credit cards can be 16 to 20% or more, while a second mortgage can be obtained at 5-9%, representing a substantial overall savings to the homeowner.
But to take out a second mortgage that it not going to give you either of these ends-add value to the home, or save money on consumer debt- is not a good choice.
If a homeowner defaults on his home, the first mortgage will be paid off from the proceeds of the property. The second mortgage is not paid unless there are funds still left after the first mortgage is settled.
It is for this reason that second mortgages have higher interest rates than first mortgages. One of the components determining interest rates is risk, and since the bank granting the second mortgage has a higher risk because the loan will not be paid off unless the first mortgage is paid off, this is reflected in the rate.
There are closing fees associated with all mortgages, but the closing fees for second mortgages tend to be higher than for first mortgages. Be aware of all of the costs so that you can compare it to the benefit you plan to receive (the amount of increased home value, or the savings on credit card debt.)
Since a first mortgage is for a substantial portion of the value of the home, it is for a greater amount than a second mortgage, so the closing costs are spread over a larger amount. The effect of the closing costs on a smaller second mortgage can be significant. It is also important to shop around for a second mortgage since rates on these mortgages can be very different from bank to bank.
by: Miriam W. Ortez
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