When A Second Mortgage Is A Good Option

When A Second Mortgage Is A Good OptionThe decision of whether or not to get a second mortgage can be a rather stressful experience, especially when you consider the fact that you’re borrowing against your home. It’s easy to find yourself in over your head, and there are cases where getting a second mortgage is simply a delay of the inevitable – bankruptcy, foreclosure or other financial distress.

That said, there are some instances when a second mortgage is a good option that can be very beneficial.

What Is A Second Mortgage? How Does It Work?

A second mortgage is a secured loan, with your home used as collateral. The lien associated with the second mortgage is secondary regarding priority, with the first mortgage taking precedence. In other words, the lender of your first mortgage has first dibs on your home. This is associated with a slightly higher risk for the lender, translating into higher interest rates on second mortgages.

Challenges can arise when refinancing the primary first mortgage, as the homeowner must request a subordination letter from the second mortgage lender. Otherwise, the second mortgage lender would take priority, stepping ahead of the first mortgage lender.

If you were to default on your second mortgage loan, missing a number of payments, the lender does have the power to push for a foreclosure of your home to recover the money owed. This is what makes a second mortgage rather risky since you’re placing yourself in a position where you’re vulnerable to foreclosure. (Although, notably, the first lien holder still has priority, even if the lender on the second mortgage initiates the foreclosure.)

There are two basic types of second mortgage. With one form of second mortgage works just like a typical mortgage, where you get a loan for X, and that full sum is disbursed at once. Then, you pay a fixed monthly fee over the course of the amortization period.

The other form of second mortgage is more akin to a credit card line of credit, where you’re approved to withdraw up to a certain amount. You have the ability to borrow from that credit line as needed and your monthly payments are based upon how much you actually borrow. Like a credit card, the line of credit is revolving, meaning that you can pay off your balance, then borrow again.

The second form of second mortgage tends to be the better option for most cases, as you’re not borrowing (and paying interest on) more than you actually need.

How Can You Use A Second Mortgage?

A second mortgage can be utilized for virtually anything, from home improvements and renovations, to a vacation or your daughter’s wedding.

Borrowers are really free to use their second mortgage in whatever way they feel suitable, but there are some cases where it may be a potentially risky decision since you are placing your real estate on the line. In many cases, it may be best to find a different funding source.

The best use of a second mortgage is to fund home improvements or other projects that result in increased equity. For example, if you wanted to build an addition onto your home or wanted to purchase an adjacent plot of land, a second mortgage would be a good choice since you’re adding to the value of your property.

The worst use for a second mortgage involves a situation where you’re in financial distress and potentially facing the loss of your home in the not-so-distant future. Ideally, you should avoid getting a loan to pay bills or simply to survive, particularly in cases where there’s no foreseeable solution to your financial troubles. Ultimately, you could find yourself where you’re at risk of losing your home due to financial difficulties and an inability to pay your first mortgage and/or your second mortgage.

Of course, there are exceptions to this rule. For example, if you’re seeking a cash infusion because you have to wait a year before you can access your retirement fund, then this could be an example of a scenario where it may be beneficial to get a second mortgage. A second mortgage is considered a secured loan, meaning the lender provides you with funds against collateral. This reduces the amount of risk involved, resulting in a lower interest rate than what you might see on another unsecured loan product. Compare to other unsecured loan options, where there is no collateral involved. In these cases, the lender has less recourse if the borrower goes into default, thereby translating into a higher interest rate.

It can also be beneficial to get a second mortgage to pay off higher-interest unsecured loans. Let’s say you have five credit cards, each with a fairly high interest rate. Chances are if you can get a second mortgage in an amount that equals or slightly exceeds your credit card balances, your interest rate will be far lower since your home is used as collateral. This translates into lower monthly payments.

Interest can account for a very large portion of the equation, particularly when it comes to credit card debt. Therefore, it’s beneficial to consolidate those debts using a secured loan, like a home loan, since you’ll pay less in interest. The result is a major saving in what you’ll spend on a monthly basis, thereby lowering your monthly debt payments by as much as one-third. This can allow you to pay off your debt faster, while also simplifying the debt repayment process since you’ll make just one payment every month instead of five payments.

Some homeowners may also be tempted to get a second mortgage to pay off student loans, but this may not always be a good decision because student loans are often very very low interest. If the student loan interest rate is lower than the interest rate on your second mortgage, it would be a poor financial decision since you would see a higher total cost in the long-term.

It can be quite beneficial to get a second mortgage to help pay tuition or startup costs for a new business, as this places you in a position to improve your financial position. Of course, there is an element of risk involved with a business startup, but if you’re committed to starting a new venture and it’s just a matter of how you’re going to borrow (rather than if), then a second mortgage can be a good choice. The secured nature of a second mortgage means it tends to have a far lower interest rate than what you might see on a traditional business loan (which is usually unsecured and associated with very high risk, carrying a significant interest rate.)

A second mortgage is just one lending solution that can help you achieve your dreams, but it’s important to look at the big picture to ensure your decision is financially sound.

About The Author

Simon Campbell has spent over 15 years in all the various facets having to do with real estate including sales, purchases, investment and research. Now after gaining such a wealth of personal experience, Simon has changed directions and is now sharing his knowledge and experience with others through writing, mentoring and consultation on his website.

 

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