A second mortgage loan on one's home is taken as subordinate to the first loan. The loan is sanctioned against the same property for which the first loan was sanctioned. Lenders consider second mortgage loan as high risk and therefore charge a higher rate of interest when compared to the first one.
What is a second mortgage loan?
A second mortgage is subordinate to the first one because in case there is a default on the payment, the first loan gets paid off before the second loan. Monthly payment towards second mortgage is lower when compared to first mortgage as the loan amount is smaller. Second mortgages are available in both fixed-rate and adjustable-rate options. With a second mortgage loan, a person can borrow up to 95% of the property value.
The most important aspect of a second mortgage is that the first lender has to issue a no-objection for the borrower to borrow a second mortgage. In most cases, you are not required to reside in the house to be able to seek a second mortgage loan. But if you are taking a 100% or 125% second mortgage loan, occupying the property becomes mandatory. Closing cost for second mortgages are around 3% to 6% of the loan amount.
Second mortgage loans are taken for funding home improvement or debt consolidation if your credit history is good and you don't want to take expensive credit card loans.
Second mortgage types
Home equity loan: This is the most common type of loan. A fixed amount of money is borrowed and is paid over a fixed period of time. These loans are usually fixed rate loans.
HELOC (Home Equity Line Of Credit): The lender fixes the limit on how much a person can draw and the person is asked to pay interest for that amount only. These loans are useful for home improvement and these loans have a floating interest rate. An interest only payable option is also available.
Piggybank loan: Very rarely these days, piggybank loan was used to secure second mortgage on the down payment, i. e. 20% of the total loan value. Through a piggy bank loan, the financier would actually be financing 100%. He would be paying 80% of the home value as primary mortgage and the balance 20% (down payment) as second mortgage. Not many financiers are open for this kind of loan.
Second mortgage checklist
Check out the following before settling in for a second mortgage:
- Terms and conditions
- APR – Annual Percentage Rate
- Cost to procure the loan
- Hidden costs if any.
Risks of secondary mortgage loans
Before you go in for a second mortgage loan, it is essential that you take stock of your financial status. When you default on a secondary mortgage loan, it affects your credit score. Defaulting on a second mortgage loan can also cost you your property. Either the primary or secondary lender can purchase the others' stake and then foreclose.
In most cases, 125% second mortgage loans are taken to raise cash quickly or for consolidation of existing debts. When you take your secondary mortgage loan with the existing mortgage lender, you might save on some fees. Some finance companies lend second mortgage loans to those who have enjoyed good credit history but have suffered sudden financial hardship. But such loans are also expensive. To start with, you will pay nearly 10% as fee up front. The finance charges and closure fees are also higher. But if you are adding to the value of the property or substantially reducing other debt, it might be worth the effort.
Second mortgages mean small down-payment or no down-payment at all. The borrower has the option of splitting his loan into two separate loans called the combo loan option, this way the risk is split equally between both the loans. Second mortgage provides a refinancing opportunity for the first loan. EMI is lower when compared to first loan.
Second Mortgage Refinancing
This type of financing helps people pay off bills, school fees, taxes, etc. Second mortgage refinancing helps lower the home loan payment. It provides additional finance for home improvement. The borrower might have to remain in longer periods of debt. But this provides a solution for immediate financial requirements. Home owners with poor credit scores or history of late payment may not find it easy to find second mortgage refinance. A second mortgage refinance is considered useful because interest rates are comparatively lower and money is available immediately for immediate use. Second mortgage refinancing could involve the following costs:
- Application fee for processing the loan request as well as checking the borrower's credit level.
- Loan origination fees and points charged to evaluate and prepare the mortgage loan.
- Home inspection fee
- Survey cost
- Lenders attorney fee
- Title search and insurance
- Homeowners insurance
- Mortgage insurance
- Escrow funds.
Benefits of Second Mortgage Refinance
- No equity is required.
- Tax deductible
- Consolidating the debts will lower monthly payments.
- Need not touch existing first mortgage.