A second mortgage is simply a loan secured against your property as collateral. The term “second” indicates that the loan does not have priority on your home in case you default. Should that happen, your first mortgage has priority and that loan would be paid off before any funds go towards the second mortgage.
As a result, second mortgages come with higher interest rates than first mortgages. Second loans require fees and closing costs, just like first mortgages. You may also be required to pay points (one point is equal to one percent of the loan value) which could make the loan less attractive. You’ll need a good credit score and documentation for enough income to make the payments.
Three popular ways buyers and homeowners save money with second mortgages:
Avoiding private mortgage insurance. Buyers lacking a large down payment can use a second mortgage to qualify for their first mortgage without having to pay expensive private mortgage insurance.
Staying within GSE loan limits. With prices rising in the nation’s more expensive markets, buyers can buy a home that exceeds the limits for a loan to be bought by Fannie Mae, Freddie Mac or Ginnie Mae without incurring the higher interest rates of a jumbo loan. That translates into a significantly lower rate of interest on the primary loan.
Consolidating high interest consumer debt. Some homeowners pay off high interest short term debt like credit cards with lower interest, long term debt through a second mortgage.
Additionally, taxpayers in higher tax brackets get to deduct the interest they pay on both mortgages on their federal and state returns.
However, second mortgages have their risks:
- By taking out a second mortgage, you are adding to your overall debt burden. Anytime you add on to your overall debt burden, you make yourself more vulnerable in case you then experience financial difficulties that affect your ability to repay your debts.
- If you cannot repay, you could potentially lose your home because you are using the equity in your home as collateral.
- If you are consolidating debt, it’s not wise to substitute short term debt for long term debt if you end up paying more over the life of the second mortgage.