A second mortgage is a supplement to the first mortgage. In simple terms, it can be defined as a property lien that is placed on a first mortgage. A second mortgage is also called as a home equity loan.
When a person has been living in a home for a long enough time, then the home builds up in value. This appreciated value of the home is called as the equity. The equity is also built up when some part of the principal is already paid off while making the monthly payments. This enables the borrower to take a second loan against the equity that has built up over the years.
While taking a second mortgage, care should be taken that the total payments on the first and the second mortgages do not go beyond affordable limit. One way to determine this is to check that the total value of the mortgages does not exceed 80% of the market price of the home. This said, it must be pointed out that current trends in mortgage rates have enabled borrowers to go well over the 80% ideal limit. Interest rates on mortgages are going downwards; so borrowers are becoming more and more able to make their payments. Today, lenders may also provide second mortgages that go over 130% of the value of the home.
Second mortgage does have its risks. Since the second mortgage is taken over the first mortgage, in any case of default the primary mortgage needs to be paid of before. If the property is auctioned by the bank, then the money obtained will be used in paying off the first mortgage. After all the costs of foreclosure are done with, the remaining money, if any, will be used to repay the second loan. Generally the money is insufficient to cover up for the second loan. Just think, if the first and second loan combined together can go up to 130% of the total home value, then how can selling the home cover both the loans as well as the charges required for foreclosure? So the defaulting borrower will still be stuck up with the second loan to pay back.
Even considering the point of view of the lenders, the second mortgage is a risky proposition. Lenders are very much unsure about how they will recover the second mortgage amount in case of a default. As a result, they charge higher interest rates on the second mortgage in order to protect themselves. The lower the equity on the home, the higher the interest rates will be.
Lenders are also stricter considering the terms of repayment. The period offered to repay a second mortgage is generally shorter than that available for a primary mortgage. The period of repayment would hardly extend ten years. This is because of the insecurity that rests in the minds of the lenders. Also the amount of the second mortgage will be significantly lesser than the amount given in the first mortgage.
Though the second mortgages are to be paid back in equal monthly installments, the terms may be different. Lenders may also ask for different kinds of repayments. One method generally used is the balloon payment. In this the interests only are collected for the life of the loan and the borrower will have to pay the principal, either in full or periodically. This balloon mortgage would be difficult if there is no provision for making the balloon payment at the end.
Getting a second mortgage is no big deal if you already are a few years into the first mortgage. But the problem is with the repayment. If you know how much you can stretch, then you can go ahead and get your second mortgage by all means.
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