Pros and cons of second mortgage loans

Think twice before taking out a second mortgage

Trying to find an adequate loan to satisfy your needs, can be a time consuming and rather daunting task. This is especially true when we talk about mortgage loans. There are various types of mortgage loans from which we can chose. But, in order for you to be able to make a right decision, you must understand what are the pros and cons associated with each type of mortgage. One type of mortgage loans, that are widely used are the second mortgage loans. Before deciding whether this type of mortgage loan will satisfy your financial needs, you should try and understand some of its basic advantages and disadvantages.

In addition, you should also identify the characteristics of an adequate loan for you. Not every mortgage offer is in accordance to your needs and preferences. Thus try to have a clear picture of what would be an ideal loan for you.

Second mortgage loans explained

As with the original mortgage, second mortgage loan is a loan guaranteed with a collateral. The collateral is you home. There is one major difference between second mortgage and original (first) mortgage. The second mortgage uses the equity you have accumulated in your home. You can build your equity in two basic ways. First, the equity could be accumulated during the years as you pay out your original mortgage. Next, your equity can increase with the increase in market value of your property.

There are two basic forms of second mortgage, these are: home equity loans (lump sum) and home lines of credit. If approved for a home equity loan, the lender will give you a lump sum of funds, at once. The repayment of home equity loan is made on a regular basis over a pre-specified period. Meaning that you will have a fixed monthly payment. In addition, the common type of interest rate for this form of second mortgage is fixed interest rate.
After approval of the home equity line of credit, you can use the available funds as you need them. Unlike, the home equity loan, adjustable interest rate is common for the home equity line of credit.

Because of the importance for every borrower to grasp the pros and cons associated with each mortgage, what follows are the basic pros and cons of second mortgage loans.

Pros of second mortgage

Interest rates – because second mortgage is a form of secured debt it bears a lower interest rate compared to other types of loans. Since your loan is secured against your home, the risk for the lender is lower. Namely, in case you default on your loan, the lender can cover the loan amount by selling the collateral (your equity).

Loan amount – the fact that second mortgage is a secured loan, you are able to borrow larger amounts. The amount you can borrow can be up to the value of your equity.

Tax benefits – are possible for the interest cost for second mortgage. Namely, the interest paid could be a tax deductible, but for this matter, consult your adviser.

Spend it as you want – is yet another advantage of second mortgage loans. Since you receive the money as a lump sum or available to you as you need. Nobody is telling you how to spend these funds. You can spend them for whatever you want. Although this can also be a drawback, for financially irresponsible person. In a way that, if you are not responsible with the money, you could end up spending them in unproductive ways. This means, that you will have no benefit from the second mortgage, but you will have the obligation to repay it.

Cons of second mortgage

Foreclosure – is one of the biggest risks associated with second mortgage loan, because you are using your home as collateral. If for some reason you fail to pay your monthly payments, your lender has the right to take your home through foreclosure. The consequences for you are obvious, you can be left out on the street. Thus, make a wise decision regarding the reason for taking a second mortgage. Do not use this type of mortgage for regular purchases.

Cost of the second mortgage – can be a bit higher. There are different activities associated with this mortgage, during the application process and approval process. All these activities will cost you money. You will have to bear the cost for appraisal, credit check, origination fees, plus other fees depending on the lender (Note: always look for the hidden fees).

Interest rate – although it has been mentioned as an advantage, interest rate is also disadvantage of second mortgage loans. Namely, while this type of mortgage charges lower interest compared to credit cards, it charges higher interest rate than the original (first) mortgage. This is because, in case you fail to make payments, first in line to repay its loan is the lender of the first mortgage. The lender of the second mortgage will cover its loan with the money left after the first lender is paid off.

Uses of second mortgage loan

As with every other loan, the second mortgage loan also has its general purposes. Namely, you should be careful about the reason you are taking on a second mortgage. Make sure that you use the money from your second mortgage in a productive manner, don’t spend them on everyday purchases. Don’t spend the money from your second mortgage on vacations either. Just remember that second mortgage is secured with your home. Most common uses of the second mortgage loans are:

  • Debt consolidation – for the purpose of securing a lower interest compared to the one you are paying on your current debt. Furthermore, you could take second mortgage to consolidate all of your monthly payments into one single payment.
  • Home repairs and improvements – can be a productive use of your second home. This is under the assumption that these repayments and improvements will increase the value of your home.
  • Buy second home – some borrowers use the funds from second mortgage to buy second home. The second property could also be an investment property, which can be further rent and earn you a rent income.

With the original mortgage you are purchasing a home or property, and build an equity over time, by repaying the principal amount. When it comes to second mortgage loans, you are putting the accumulated equity as collateral. This means, that you must pay close attention regarding the uses of the funds obtained with second mortgage loans. Namely, you should not risk your equity, if you plan to use the money from second mortgage loans for unproductive activities. Use these funds in a way that will bring you some benefit (financial benefit) in the future. For instance, you can make home improvements, buy a second home (investment property) or consolidate your debt.

The way you will use the funds will make the difference whether you will enjoy the benefits, or you will be hit with the drawbacks. Always, gather enough information before making any financial decision.