What is a Second Mortgage? Advantages and Disadvantages

A second mortgage is an additional loan on your home subordinate to the primary mortgage on the property. Homeowners take out a second mortgage for a number of reasons, such as to improve their home, to consolidate their debts, or to purchase an additional home or investment property. The loan is called a second mortgage because if the homeowner defaults on the loans, the primary mortgager would get paid first before any money goes to the second mortgager.

Advantages

There are several reasons why you might consider taking a second mortgage on your home.

• The main advantage is the ability to access a larger amount of money. Because the loan is tied to your home’s equity, you are likely to have access to more money than you might be able to with a credit card or personal loan.
• A second mortgage’s interest rate should be much lower than other forms of financing, e.g., you might pay 6% or 7% for a second mortgage versus 20% on a credit card. Borrowing against your home looks attractive in that sense.
• Interest on the second mortgage is tax deductible.

Disadvantages

There are several disadvantages of taking a second mortgage on your home.

• The biggest risk is putting your residence on the line as collateral. Since you cannot guarantee that your financial situation will remain stable, you may end up losing your home if you find you can’t pay the second loan, especially if you don’t have enough cash to make payments on the first mortgage loan.
• Once you have a second mortgage in place, refinancing will be very difficult to do because your loan to value ratio will be very high.
• The interest rates you will pay are often higher than your first mortgage. The higher interest rate is charged because of the added risk for the lender (since a default puts the second mortgage at a lower priority than the first mortgage).
• There are some steep fees associated with securing a second mortgage. There is a lot of work involved in getting a second mortgage. You will have to have your home appraised and pay for closing costs again. For some, the cost of the fees may not be worth the actual loan. It will depend on the amount of loan you are seeking and how long your loan terms will be.
• Lastly, other options, such as cash-out refinancing and HELOC might be better suited for your situation.

How to Get a Second Mortgage

Second mortgages are not hard to find and it’s in your best interest to first speak with the bank or lender that holds your first loan. Next, check in with a credit union or local community bank that is happy to take your business away from the bigger banking institutions. Be sure your credit score is high and your credit history is clear before applying. Also make sure that the repayment terms are something you can handle in light of your other monthly financial obligations.

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