A mortgage is a loan issued by a mortgage lender or a bank that allows an individual to purchase a home or property. A second mortgage is a mortgage on a mortgage also called a subordinated mortgage while the original mortgage is in effect. If there is any default then the original mortgage will receive all money from liquidated damages till the loan proceeds are paid off.
The payments for the second mortgage will be received only if the first mortgage has been paid off. The percentage of interest will be higher for the second mortgage and the amount released for the second mortgage will also be lower. The reason is that there is a higher risk associated with a second mortgage.
A second mortgage is a loan which is made along with the primary mortgage. Home equity line of credit is generally used as a second mortgage. The owners of houses will do a second mortgage generally to get loan amounts for making big purchases like buying a new vehicle, paying for college seats and sometimes even making a down payment for another home.
Second mortgage has a higher interest rate than the first mortgage and it has a lesser interest rate compared to personal loan or interest on credit card charges. Though it is expensive to opt for a second mortgage it is comparatively less costly than other forms of debts. The debtor should pay upfront closing costs similar to the first mortgage. There should be good equity in the home to take advantage of a second mortgage to obtain a decent amount of money.
How does Second mortgage Work?
Generally when people buy a home or any property they will take a home loan from the bank or financial institutions. These lending institutions use the property as collateral and issue the loan amounts. The loan issued by pledging the collateral and charging an interest rate is a first mortgage. The borrower should repay the loan amount to the lender according to the terms of the agreement. Generally, the loan amounts are paid in the form of monthly installments which includes a portion of the principal and interest amounts. Over a period of time by regularly paying the principal and interest the borrower owns the property and the home also gets good market value in the form of asset appreciation.
The borrower can also choose the option of generating funds through the home equity. Home equity means the difference between the current market value of home and the remaining installments on the mortgage. To fund the home project the option of borrowing against the home equity is called a second mortgage. It is called a second mortgage because the home already has a first mortgage. The amounts of the second mortgage are paid lump sum to the borrower during the loan closing period.
Similar to the first mortgage, the second mortgage should be repaid as per the timeline. The interest charges are according to the fixed and variable interest rates. They depend on the loan agreement which is signed with the lender. The loan must be paid off first before the borrower can get another loan through home equity.
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Home equity line of credit
Home equity line of credit is used as a second mortgage. It is a revolving line of credit that is created by the equity lender in the home. Home equity line of credit is structured finance similar to a credit card account. In this form of structured finance the borrower is allowed to use a credit amount which is predetermined by the lender. The monthly payments are made on the account depending on the outstanding balance on the loan.
The payments will increase as the loan balance increases. The interest rate and the second mortgage are lower than unsecured loans and credit cards. The second mortgage loans are used for getting finance amounts for larger expenditures which are difficult to obtain otherwise.
What are the requirements for a second mortgage?
You should meet certain criteria to qualify for a second mortgage. These include having a very good credit score, debt to income ratio at 43% and you should have a decent credit amount in your first mortgage. Since you are using equity in your home for a second mortgage you should have good equity to get a second loan. You should keep nearly 20% of home equity in the first mortgage.
Things to note
You can borrow a huge amount of money with the second mortgage. Second mortgage loans are used as collateral so more equity you have is good for getting a high borrowing amount.
The timeline for approval may vary depending on the location, property and other factors. The appraisal of the home should be done which will take a week’s time according to underwriters. It could also take one month or more depending on the external factors.
Similar to the first mortgage, there are costs associated with taking a second mortgage; these expenses include origination charges, appraisal fees and credit checking expenses.
Not all the lenders prefer to issue second mortgages as there is a lot of risk involved in issuing second mortgages. Similar to purchasing a mortgage there are costs associated with a second mortgage. The lender ensures that the borrower is in a good financial position to repay the second mortgage. The lender will check the borrower’s credit worthiness and decide whether to issue a loan or not to issue a loan.
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Advantages and disadvantages of Second Mortgage
You can access a large amount of money with the second mortgage when you are using the home as collateral. There is an element of tax benefit and the interest rate is also very less. Second mortgage can be used to get finance for major expenses.
Advantages
- Makes big ticket purchases possible.
- Access to equity
- Interest rates are lower compared to private loans or credit cards
Disadvantages
- If you are unable to pay second mortgage you will lose the mortgaged asset
- It is expensive to close second mortgage
- If there is no appraisal on the home and there is no good equity on the home, you will not be able to get a second mortgage loan.
About the author
Vinay Kumar Goguru is a finance professional with more than 8 years of diverse experience as a researcher, instructor and Industry work experience with both public and private entities. Prior to MyMoneySouq, he spent 6 years in Berkadia, It's a commercial mortgage banking company. He has a "Doctoral Degree in Commerce" and two master's degrees with a specialization in Finance, one as Master of Commerce and other as Master of Business Administration. He has written several articles on personal finance, published by different International journals. He loves traveling, reading and writing is his passion. He has a dream of writing a book on his favorite finance topics.
