What is a Second Mortgage?
A second mortgage, like the name suggests, is a loan taken out on a property that is already mortgaged. Simply put, it is a second loan on the same property. In case there is a default on the loan, the property will be sold and the proceeds will be used to pay off the first loan. The remaining proceeds from the foreclosure, if any, will be used to pay off the second mortgage. So, the lender runs a risk that he may not recover the money he lent. Considering the risk involved, the interest rate is understandably higher.
A second mortgage has its share of restrictions. For instance, you don’t get to decide the amount as it is decided by the built-up equity. The built-up equity on a property may be defined as the difference between the market value and the number of mortgage payments due. Hence, if your property is worth USD 100,000 and your outstanding mortgage payments are USD 65,000 then you will receive an amount of USD 35,000.
Sometimes, although very rarely, there is a chance that the lender will allow your total debt to go up to 125% of your property value. In this case, you can obtain an amount of USD 60,000 on your second mortgage. But the chances of that are very rare in the present circumstances and require an excellent credit history.
Advantages
- The main advantage is that you can avail financing when you need it, despite having mortgaged your property once. Using this amount to purchase another asset would be a good idea.
- It buys you time. Suppose you realize that you aren’t going to be able to stick to your payment commitments, you can quickly take up a second mortgage to help pay off the old mortgages.
- It can be used as a Home Equity Line of Credit (HELOC) to make improvements to the home.
- The interest on your second mortgage might just be lower than your first loan, if the overall interest rates have fallen.
Disadvantages
- It puts your personal finances at more risk. If you are drawing an amount more than your property cost, there is a chance of bankruptcy.
- Although, I mentioned a point before about a lower interest rate, the chances of that happening are very rare and most probably you are going to get stuck with a pricier loan.
- If you obtain a 125%-of-property loan, then the interest payment on that extra 25% is not tax-deductible.
Recent policies have decreed that these types of loans be made cheaper, so that the people can pull themselves out of the current financial crisis. But remember, this financing has to be used with caution and responsibility. People have to use this money responsibly to rebuild their finances and not squander it away.
