Just like you have a primary mortgage, you can also have another mortgage. There are few differences between a primary and a second mortgage, and we’ll discuss them in this post.
We’ll also discuss the pros & cons of second mortgages and whether you should get one.
What is a Second Mortgage?
First, let’s understand what a primary mortgage is.
You buy a house and find a lender who can finance that property. The lender evaluates the property and then decides whether he should lend you money for the given home. The property acts as collateral. You are the owner, but the lender uses the property as a collateral to lend you the funds. Your primary mortgage creates a lien on the property. That means, if you default, the lender can sell the property to recover his funds.
A second mortgage is different in the sense that it’s taken from the equity of your home. Let’s say; you took a mortgage back in 2007. After 12 years, you have $75,000 invested in your home. In other words, your equity is $75k. That means you can take a second loan worth $75k.
The second mortgage has less priority compared to the first mortgage. In case of a foreclosure, the first loan will be paid in full. After that, remaining funds will be used to pay off the second mortgage. It’s important to note that you don’t have to use the same lender to get both loans.
Why is the Second Mortgage Needed?
Mortgage products almost always have a lower interest rate compared to credit cards. If you are in credit card debt of $20k, that can be a huge problem. With a double-digit interest rate, it can be challenging even to pay the minimum monthly installment.
If you take out a second mortgage, you can reduce your credit card debt to $0. Paying off credit card debt, student loans, medical bills, and purchasing investment property are all good reasons to consider a second mortgage.
You’ll repay the second mortgage just like the previous loan. There will be monthly payments with some interest rate.
Pros and Cons of a Second Mortgage
- It’s possible to access cash without using your credit cards. You’re not borrowing from someone else. You are tapping into your home’s equity.
- There is also a lending limit which is a good thing. You can borrow up to 80% of your home’s value. When you apply for this type of loan, the lender will re-appraise your house. Let’s say you purchased the house in 2007 for $180,000. If market conditions are right, your home could be worth $220,000. That means the money you have invested in the house has also earned an ROI.
- You get an affordable repayment plan. Compared to credit card debt, it can be much easier to pay off a new mortgage.
These types of loans are subordinates to the primary loan. For the same reason, these mortgages come with a high-interest rate. However, as per the current market conditions, we can assure you that interest rate is never as high as credit cards.
You are taking a new mortgage so you’ll need to pay appraisal fees, processing charges, loan origination fee, closing costs, and other associated fees. It would be best to consider these costs before you apply for a home equity loan.
Your home can be at risk. Perhaps, the most significant disadvantage of a second mortgage is that you’re risking your property. It can be challenging to pay two mortgages each month. Missing even one loan payment can create trouble, and if you cannot pay the second loan, the lender can foreclose your property.
It’s not possible to refinance the primary mortgage after you have taken a home equity loan. That’s because of their priority level. When you refinance the first loan, the second loan becomes the priority. Banks know this fact, and they are not going to let you refinance the first loan.