Second Mortgage
A second mortgage can provide a valuable source of funding for high-dollar expenses. However, because the second mortgage is tied to the home, it should never be undertaken without careful thought and understanding. While it is highly recommended that you seek legal and financial advice from a qualified professional before making any major financial decisions, this brief guide can help you better understand the risks and benefits that may be involved.
What Is a Second Mortgage?
Simply put, a second mortgage is a mortgage on a home that already has a
mortgage. The term "second mortgage" refers to the fact that if you
default, the first mortgage will be paid off first. This makes a second
mortgage riskier for the lending institution, which generally translates to
higher fees for the borrower.
Who Can Qualify for a Second Mortgage?
A second mortgage provides funds based on the equity in the home. Lenders
generally loan up to 85% of the available equity. However, in some states
lenders are permitted to offer up to 125% of the equity in the home.
Because a second mortgage is riskier for the lender, it can also be more difficult to get approval than for a primary mortgage. Generally the borrower must demonstrate a consistent employment history, good credit score and a low debt-to-income ratio.
Benefits of a Second Mortgage
A second mortgage is valuable in situations in which the benefits outweigh
the risks. Second mortgages are often used to pay medical or educational
expenses or to perform major home repairs or renovations.
A second mortgage can sometimes be piggybacked to a first mortgage in order to achieve a 20% down payment and avoid paying for private mortgage insurance. Extreme caution should be used in this scenario to avoid paying more for the second mortgage than the PMI would have cost. A financial advisor can help you decide whether this is the right option for you.
Risks of a Second Mortgage
Because the second mortgage is tied to the home, defaulting on the loan
can result in the home's foreclosure. It is very important to only borrow
what you are sure you can afford to repay. Mortgage protection insurance
can help to protect you from unforeseen circumstances such as disability or
involuntary unemployment.
The Bottom Line
A second mortgage can provide a valuable source of funding by allowing you
to tap into the equity in your home. As a mortgage, however, the second
mortgage also carries a significant risk. A qualified financial
professional can help you weigh your options and find the second mortgage
that is best for you.
