A second mortgage is basically 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.
In the past, the total amount of debt from a first and second mortgage combined could not be more than 80%
of the home’s appraised value. Recently however, low interest rates and a hyper-competitive marketplace
created a lending environment where some lenders were approving second mortgages that, when combined with
the first mortgage balance, totaled as high as 125% of the home’s appraised 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%.
A second mortgage is always subordinate to the first mortgage. This means that in the event of a default, the
property is sold and the proceeds are used to pay the first mortgage first, including any legal costs and other
costs of the sale. The remaining proceeds are applied to the second mortgage. If there is not enough money
remaining from the sale of the home, the second mortgage does not get paid.
A Higher Interest Rate for Second Mortgages
Before a lender is willing to loan money out for a home mortgage, he looks at the risk level to him to determine the interest rate to charge. That is why a high risk borrower with a poor credit history gets charged a higher interest rate compared to 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.
Second Mortgage Terms
In general, the terms given for second mortgages are shorter than those for first mortgages – primarily because
the dollar amount of the second is generally much lower than that of the first.
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 2nd 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.
Second mortgages come in two basic types, fixed rate and home equity line of credit (HELOC). Fixed rate mortgages are the standard offering. The HELOC mortgage is a little unique and has been very popular of late. Typically this loan calls for interest only payments for the first 5 to 10 years with the line of credit frozen at the outstanding balance of the loan. The loan payments are recast at that point and a standard principal and interest payment schedule is established for the remaining 10 to 20 years. HELOC’s are typically priced with a variable interest rate indexed to the New York City prime interest rate.
HELOC interest rates are similar to 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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