Understanding a Second Mortgage
A
second mortgage is a loan that you take against the equity that you have
already built into your home. The proceeds from the second mortgage can
generally be used for whatever purpose the borrower has in mind. It can be
used to pay off a car loan or credit cards. The proceeds can be used for
home improvement or to take a vacation. The money can even be put in a
savings account for a rainy day fund.
Historically the total amount of debt from the first and second mortgage
combined could not be more than 80% of the total market value of the home.
However, low interest rates and a competitive marketplace have created a
lending environment where some lenders are approving second mortgages that,
when combined with first mortgage balance, is totaling as high as 125% of
the home value.
However, financial advisors will tell you that carrying that much debt on
your home is never a good idea. I never recommend borrowing more than 100%
of the value of your home and I rarely recommend a second mortgage with a
loan to value of greater than 90%.
Because a second mortgage is a property lien that is placed behind the first
mortgage, this means that in the event of a default, after the property is
sold the first mortgage gets paid first, including any legal costs and other
costs of the sale, before the second mortgage can be paid. If there is not
enough money from the sale of the home, the second mortgage does not get
paid.
A Higher Interest Rate
When
determining the interest rate that a lender is willing to loan money out for
a home mortgage, he looks at the risk level to him for loaning that money.
This is the reason that a high risk borrower with a poor credit history gets
charged a higher interest rate than a low risk borrower with a strong credit
history.
The
same theory holds true with a second mortgage. Because the lender of the
second mortgage is second to be paid off in the event of a default, and
because there is a greater chance that there might not be enough equity in
the home to pay off the second mortgage in full, second mortgages are
usually given at a higher interest rate than are first mortgages;
irregardless of who the borrower is.
Terms
Although you will have choices for terms when selecting your second
mortgage, in general the terms given for them are shorter than those of a
first mortgage. This is primarily because the amount of the second mortgage
is generally much lower than that of the first mortgage.
Second mortgage repayment terms can vary considerably, so it is important
that you look around for the one that is best for you. For the most part
they range in length from 5 to 20 years, with the majority of second
mortgage loans being 10 to 15 years. A select number of lenders will offer
a 30 year amortization and some of them will balloon (set a maturity date)
of 15 years. This loan is called a 30 due in 15. Generally, just like
first mortgages, the longer the maturity, the higher the interest rates.
Also, just like first mortgages, the higher the credit score (FICO) the
lower the interest rate.
Types of
Second Mortgages
Just
as the length of the second mortgage can vary, so can other repayment
terms. The majority of second mortgages are paid back in equal monthly
payments with a portion of the payment going to interest and a portion to
the principal balance, just like a first mortgage.
The
two most common types of second mortgages are the fixed rate and the HELOC.
(home equity line of credit) The former is a standard offering. The HELOC
is a little unique and has been very popular. The loan typically calls for
interest only payments for the first 5 to 10 years and then the line of
credit is frozen at the outstanding balance of the loan. At that point, the
loan payments are recast and a standard principal and interest payment is
established for the remaining 10 to 20 years. The HELOC's are typically
priced with a variable interest rate that is most commonly indexed to the
New York City prime interest rate.
Pricing on the HELOC's is like other loan pricing; the lower the FICO score
and the higher the loan to value, the higher the interest rate.
When
considering a second home mortgage, be sure to shop around and then talk to
lenders to ensure that you get the best deal for you!
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