Second Mortgage

What a Second Mortgage Is

A second mortgage is a loan secured by the value of a property that already supports another "first" mortgage. It can be found in two variants: One is the traditional mortgage, in which the borrower is paid all the loan money in a single initial payment and is then amortized in a monthly payments schedule. This is known as a Home Equity Loan and usually pays a fixed interest rate; The other is a line of credit that lets you withdraw money at your convenience and repay it with a very flexible schedule and variable interest rate. This type is called a Home Equity Line of Credit, also known as a HELOC.

A second mortgage lets you monetize the value accumulated in your home along the years. Second mortgage rates tend to have higher interest rates than first mortgages, but lower than other sources of cash like unsecured loans or credit cards, and more convenient repayment options. They also have some tax benefits that make them even more affordable.

Why a Second Mortgage

Second mortgages provide an alternative source of cash in financial emergencies. If you face the need to pay for home repairs, or if you need some home improvements, or pay college costs for the kids beyond what financial aid can cover, or face large expenses like buying a new car or furniture or finance a costly vacation or simply to enjoy your retirement with financial freedom, then you can tap the equity built on your home by means of as second mortgage, either a Home Equity Loan or a HELOC.

A HELOC can even be a great alternative to an emergency fund, for unexpected bad turns of life. A second mortgage can even help repair a damaged credit history, as long as you make your payments on time. For some cash emergencies, an Interest-Only Second Mortgage, in the form of a HELOC may be the most convenient solution. It brings reduced paying pressure by requiring only a minimum monthly installment, while letting the equity in your home build up to provide positive cash flow and collateral.

Second Mortgage or Refinance?

If you decide to use the equity accumulated in your house as a source of cash, you can do it by means of a second mortgage or by refinancing your old first mortgage. What is best for you depends on several factors you should consider:

• The loan application process for a HELOC is far less complicated than for a first mortgage or for refinancing a first mortgage, and closing fees are minimal. On approval, a credit limit is established and you can draw against it whenever you want and pay interest only on the amount you borrow. In some HELOCs, you even can postpone payments of principal for several years. However, after the interest-only period expires, the loan is amortized through monthly payments as in a normal mortgage.

• Second mortgages have higher interest rates than refinanced first mortgages. This is because lenders see higher risk in second mortgages, as in case of default on the loan and the house is sold, the second mortgage lender gets back only what is left after paying all legal costs and the first mortgage. This fact makes second mortgages expensive for log term loans.

• The above factor tend to make refinancing cheaper for larger and longer loans, while second mortgages tend to be the best choice for smaller and shorter loans. Most second mortgages have terms of 5 to 10 years, although they can be shorter or longer.

• Second mortgages imply two loan monthly payments instead of one, and, consequently, higher financial pressure. The borrower must carefully consider if the additional expense can be afforded. However, the importance of this factor can be minimized if instead of a fixed-term Home Equity Loan the borrower takes a HELOC with a flexible repayment schedule.

• For smaller short-term loans, a second mortgage seems to be a better choice than refinancing due to the costs involved. Typically you need to keep the loan for about two years to break even in refinancing a first mortgage. Second mortgages do have minimum balance and early pay off fees, but they are significantly less than refinancing fees.

• Second mortgages have higher approval rates than first mortgages.

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