Second Mortgage Tips

What is a second mortgage?  Simply put, it is an additional loan taken against a property. Since a first mortgage must be paid off first, lenders consider second mortgages riskier.  For this reason, they typically charge higher interest rates and points for the transaction. Second mortgages are different from refinancing initiatives. When you refinance a first mortgage, you're essentially renegotiating the terms of the first loan. A second mortgage, on the other hand, involves borrowing against the equity you've already up built up in your property.

The most straightforward type of second loan simply involves hedging your equity for cash or credit now. For instance, let's say that you've paid off $40,000 on a first mortgage of $200,000. You can then take a second mortgage to borrow against that $40,000 you've already paid. Since the bank or lending institution knows that the money is secured, you will likely get a relatively good rate.

You can also take a second mortgage for more than you've stored up in equity. A 125 percent second mortgage is a common increment here. Typically, lenders won't agree to a 125 percent second mortgage unless the homeowner has exquisite credit or other assets to help secure the loan. Even then, you may have to pay higher interest rates. Moreover, the additional interest on your mortgage may have to be paid with after-tax dollars.

You may also be able to take out a second mortgage at the same time that you purchase your home. For instance, if you only have 15 percent of your down payment in your savings, you can take a second mortgage to grab the additional 5 percent of the payment necessary to qualify for your first mortgage. As you can imagine, simultaneous second and first mortgage financing can get quite complicated, so it's important to understand the rules -- and the tax consequences -- of these initiatives before you put them into place.

It is possible to take out third mortgages (and more). However, since interest rates and penalties tend to get steeper as you put more and more stress on your equity and mortgage, most individuals opt for alternative financing plans. In terms of whether you should take a second mortgage or refinance your first, there is no one-size-fits-all answer. Analyze your interest rates, consumer debt, long-term financial picture, and equity savings before going with one or the other.