Is a Second Mortgage a Good Idea?

Are you contemplating taking out a second mortgage on your home? Here are some important factors to consider.Americans most commonly finance their home purchases with a mortgage. Home mortgage loans are generally long term loans, with the average being 30 years.

It is not at all uncommon for monetary needs to arise during the period of the loan that cannot be afforded on normal income. As a result, many borrowers take out a second mortgage.

Second mortgages enable homeowners to borrow up to the amount of their current equity in the home, and it’s used as collateral. Proceeds from a second mortgage can be used for anything; many choose a second mortgage to finance their kids’ education, home remodeling projects, or to pay off other forms of debt.

What Makes a Second Mortgage Different?

Second mortgages are slightly different than first mortgages. Second mortgage loans commonly carry higher interest rates, and the repayment term is shorter.

Balloon payments (a large single amount) are commonly added near the end of the term of second mortgages.

Under certain circumstances, it’s actually advantageous to pay off a first loan with a second mortgage. In the situation interest rates are lower than the rate at which a first mortgage was done, taking out a second mortgage with lower rates to pay a first mortgage with a high rate may be a wise choice.

It is commonly less expensive and quicker to take a second mortgage than to go through a refinancing process.

How a Second Mortgage Compares to Alternatives

Another advantage to a second mortgage over refinancing is that second mortgages normally feature fixed rates as opposed to variable rates.

There are three types of financing options to consider when borrowing in addition to a first mortgage: a standard second mortgage, a loan on home equity and a line of credit based on home equity.

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Standard second mortgages offer the advantage of a lump sum loan amount. Second mortgages are usually for a 15 year term. Interest rates of second mortgages will be higher than those of first mortgages, especially a fixed rate second.

The loan limit for a second mortgage is calculated as 75%-80 % of the appraised home value less the principal amount of the first mortgage. A credit check and a current home appraisal are required for a second mortgage.

Home equity loans are very similar to a second mortgage. However, home equity loans carry lower interest rates and closing costs can be waived unlike second mortgage closing costs. These are usually adjustable rate loans.

Home equity line of credit type loans are best for sporadic fund requirements such as a one time consolidation of debt. An appraisal and credit check are required, and interest rates are traditionally adjustable. Closing costs may or may not be waived depending on the lender.