While getting a mortgage to buy a home is fairly common, reasons to get a second mortgage may be less obvious. Home buyers and existing homeowners often use a second mortgage to finance a home purchase, home improvements, pay-down credit card debt or to purchase things they need.
Second mortgages are as important consideration than primary mortgages. The understanding of the finer points, from liability to interest rates, helps a borrower to make a practical decision regarding second mortgages.
Have questions about your mortgage? Always consult with your mortgage lender for advice specific to your needs.
Why Get a Second Mortgage?
Simply put, a second mortgage is a loan secured by the home that is secondary to the primary mortgage. There are several instances that may prompt a second mortgage, including:
- financing the purchase of the home
- financing the purchase of a second home or vacation home
- paying for home improvements
- paying off other debts, such as credit card debt
- financing other life activities
If the equity in the home has increased over time, the use of a second mortgage for home improvements or to pay off high-interest credit cards might be a wise financial decision that may save money on interest and allows the loan to be paid over a greater length of time.
What is the Difference Between a Second Mortgage and a Home Equity Loan?
Second mortgages and home equity loans are somewhat similar. A second mortgage is a loan that is secured by your home. Generally, second mortgages and home equity loans are usually loans with fixed terms with specific payment amounts. The money is usually received as a lump sum at the beginning of the loan. The loans are then paid off over time, much like a primary mortgage. However, a home equity line of credit (HELOC) is unique because it is a line of credit. This line-of-credit can be accessed more than once. A second mortgage usually has a fixed rate of interest, while a HELOC may have a variable interest rate that fluctuates while the credit line is available.
Do Second Mortgages Have Fixed Rates or Adjustable Rates?
The typical gold standard for primary mortgages is a 30-year fixed-rate loan. This means that the interest rate is fixed for the entire 30-year term. Whatever type of primary mortgage there is, the terms, including the interest rate, for the second mortgage may be different than the primary mortgage. If there is an adjustable-rate (ARM) second mortgage, which is somewhat more common, the interest rate will increase or decrease throughout the term of the loan. ARMs have clearly-defined terms that shows:
- how long the initial fixed rate lasts
- the frequency your rate can change after that first term
- how much the rate may change
- how the periodic rate changes are calculated
A second mortgage is considered a loan independent of the primary mortgage, so borrowers should be careful to understand the distinctions between the two.
What is a Junior Lien?
A second mortgage is a lien on the home or property. Should you default (not pay the payments), the house may be sold to pay off the liens. A second mortgage is often called a "junior lien" because it is secondary to the primary mortgage. This means that, if the home is sold to pay off the liens, the primary lien is paid off first. Although second mortgages are usually smaller than a primary mortgage, the size of the loan may not determine the priority of the lien. In the case of mortgages, the loan that was recorded first usually gets first priority.
Are the First and Second Mortgage Lenders the Same?
Unless a second mortgage is created when the home is purchased, it is unlikely that the same lender will own both loans. Most first mortgages are sold shortly after the home closing, often to other financial institutions or federal organizations like Fannie Mae or Freddie Mac. Even if the same lender (as the first mortgage) is used to apply for a second mortgage, the mortgage may eventually be sold to another lender. Therefore, borrowers can typically apply for a second mortgage with any lender they choose.
What if the Primary Mortgage is Refinanced?
When mortgage interest rates are low, it might be a smart financial decision to refinance the primary mortgage for a lower interest rate (with lower payments). However, a mortgage refinance might become more complicated if there is a second mortgage. If only the first mortgage is refinanced, there is usually not a problem as the first mortgage remains the first lien-holder. However, if only the second mortgage is refinanced, it is possible that the second mortgage holder might become the primary lien over the first mortgage - though the lender used for the first mortgage will typically require the owner of the second mortgage to agree to a subordination.
This means that the second mortgage would remain the junior lien after refinancing. It is possible, however, to refinance both mortgages into a single loan. However, in order to be approved, it is common that the total amount financed generally must be less than 80% of the value of the home.
What Closing Costs Come with a Second Mortgage?
Many of the same closing costs associated with a primary mortgage will apply to the closing of a second mortgage, although they are generally greatly reduced. Standard fees, such as notary costs, recording fees, and credit reports are fixed expenses and will be the same regardless of the transaction. Some variable costs, such as administrative fees and document preparation expenses charged by lenders, are likely to be lower, as are title and escrow fees. Any remaining expenses (i.e., attorney fees) are likely to be considerably smaller, but will vary depending on the lender, your credit, and how much you're borrowing.
Is a Second Mortgage Right for Me?
By placing a second mortgage on the home, the amount of debt increases that is secured by the home. Additionally, if a second mortgage is used to buy the home, then home buyer's equity begins much less than it would have been with a larger down-payment. No matter how small the second mortgage is, the borrower is expected to make monthly payments on time, just as with for a primary mortgage.
What Happens if There is a Default?
Any lender that holds a lien on your property may have the right to foreclose on the home, then sell it and use the proceeds to pay off the debts owed. Defaulting on any mortgage usually begins the foreclosure process, which underscores the importance of taking all mortgages seriously. If the home is ever sold, the owner of the primary mortgage gets first right to the proceeds. The more equity there is in the home, the more likely the second mortgage gets paid after foreclosure. Should a borrower default on their second mortgage, the equity in the home (or lack thereof) may determine the difference between the second mortgage lender either levying late fees and/or initiating the foreclosure process.
In many cases, obtaining a second mortgage might be a smart financial decision. A second mortgage may aid in the purchase of a home or help with financing home improvements. Though obtaining a second mortgage does give the homeowner additional liabilities that should take seriously. All potential second mortgage borrowers should not only answer the questions above, but find and discuss their own unique situation with a qualified second mortgage lender.
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