Second Mortgages Explained: What Is A Second Mortgage
June 30, 2010 – 7:59 pm
A second mortgage is a loan that is given by a lender that is secured against the home itself and is superceded by the first mortgage. Any mortgage that is given out against the owner’s equity in the home in addition to the existing mortgage is automatically considered a second mortgage.
If an owner is unable to make his debt repayments on his loans and is forced into foreclosure the holder of the second mortgage will not receive any money against their note until the first mortgage has been completely paid out.
Being a second mortgage holder is a more risky business model and generally requires the borrower to pay a higher interest rate than they do on their first loan for this increased risk.
Key Differences Of A Second Mortgage
- Second mortgages are usually lent for a shorter period of time (typically less than 15 years)
- Second mortgages can sometimes require a large “balloon payment” at the end of the repayment period that doesn’t happen in a fully ammortized first mortgage
- Due to the increased risk to the lender the second mortgage loan has a higher interest rate than first loans, as mentioned earlier
- Second mortgages can be used to consolidate other debt payments (like credit cards and other high interest debt) into one payment with a lower interest rate
Most Popular Types Of Second Mortgages
- Home Equity Loan – This is the traditional type of second mortgage where the entire loan amount is given out in a one time payment (typically a single cheque) followed by a regular monthly repayment schedule at a fixed interest rate.
Home equity loans can be used for a variety of things from debt consolidation, home remodeling, funding a child’s university education or other large purchases requiring a large lump sum of money. The key here is that the home equity is securing the loan unlike a credit card loan for example where the loan is unsecured.
- Home Equity Line Of Credit (HELOC) – This other popular type of second mortgage is quite a bit different in form than the home equity loan. As the name implies you will not receive a lump sum payment but a line of credit secured against your home’s equity. In fact it’s possible you may never even use any of the money in a HELOC depending on your reasons for getting it.
The line of credit type of second mortgage is money that you can borrow at a future time as needed. The amount of credit available in the HELOC does not change and can be used all at once or in several small amounts spread out over many months or even years.
The interest you are charged on a home equity line of credit is typically tied to the prime interest rate and is usually the prime rate + a certain number of percentage points. For example, you may get a HELOC with an interest rate of prime + 6%. This mean is the prime rate is 5% your interest payments will be 11%. As the prime rate changes your interest rate will also change.
If you apply and get approved for a $100,000 home equity line of credit you could use $20,000 to go buy a boat. A few months later you could then spend $40,000 to add a room to your house. Perhaps you run up a large bill on your high interest credit card, you could use the HELOC credit to pay it off. There are many uses for a HELOC just don’t get in over your head as this is still debt and should not be treated as cash or a piggy bank to be raided.
Be Careful A Second Mortgage Is Still A Debt Product
Second mortgages used to be frowned upon as a signal that the borrower was in distress with their finances but this stigma has disappeared in recent years as competition has steadily dropped rates and made these products more competitive and common.
Second mortgages are used as a way to tap the equity home owners have built to secure a loan to; purchase big ticket items or consolidate high interest debts among a myriad of other uses.
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