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Understanding a Second Mortgage

A second mortgage is a loan that you take against the equity that you have already built into your home by paying off some of the principal balance on your first mortgage loan.  A Second Mortgage is a Property Lien placed behind a First Mortgage - yet a "cross default" clause often means defaulting on payments of a second mortgage lead to an automatic default on your first mortgage...continued below

Historically the total amount of debt from the first and second mortgage combined could not be more than 80% of the total market value of the home.  However, record low interest rates and a competitive lenders marketplace have created a lending environment where some lenders are approving second mortgages that, when combined with first mortgage balance, is totaling as high as 130% of the home value.

However, financial advisors will tell you that carrying that much debt on your home is never a good idea.

Because a second mortgage is a property lien that is placed behind the first mortgage, this means that in the event of a default, after the property is sold the first mortgage gets paid in its entirety, including any legal costs and other costs of the sale, before the second mortgage can be paid.  If there is not enough money from the sale of the home, the second mortgage does not get paid.

A Higher Interest Rate

When determining the interest rate that a lender is willing to loan money out for a home mortgage, he looks at the risk level to him for loaning that money.  This is the reason that a high risk borrower with a poor credit history gets charged a higher interest rate than a low risk borrower with a strong credit history.

The same theory holds true with a second mortgage. Because the lender of the second mortgage is second to be paid off in the event of a default, and because there is a greater chance that there might not be enough equity in the home to pay off the second mortgage in full, second mortgages are usually given at a higher interest rate than are first mortgages; irregardless of who the borrower is.

Shorter Terms

Although you will have choices for terms when selecting your second mortgage, in general the terms given for them are shorter than those of a first mortgage.  This is primarily because the amount of the second mortgage is generally much lower than that of the first mortgage.

Second mortgage repayment terms can vary considerably, so it is important that you look around for the one that is best for you.  For the most part they range in length from 2 – 20 years, with the majority of second mortgage loans being 5 – 10 years.

Just as the length of the second mortgage can vary, so can other repayment terms.  The majority of second mortgages are paid back in equal monthly payments with a portion of the payment going to interest and a portion to the principal balance, just like a first mortgage.  However, some are different such as those known as interest only or balloon mortgages.  In that case your monthly payment will go only towards interest and the entire principal will be due at the end of the second mortgage term. 

When considering a second home mortgage, be sure to shop around and then talk to lenders to ensure that you get the best deal for you!