Second Mortgage: What You Need to Know
Last updated on March 2nd, 2022
Borrowers can apply for a second mortgage if they need funds on top of their current home loan. This comes with some risk but is a perfectly viable option in some instances.
How do second mortgages work?
A second mortgage sits on a lower priority level when compared to the first mortgage. In the case of default on the first loan, the priority goes to that, and the second mortgage after.
Due to the higher risk on the second lender’s part, these mortgages are much harder to approve. Also, one cannot just take out a second mortgage without permission from the lender of the first mortgage.
For a better idea of how this mortgage works, take the following situation into account. Mr and Mrs Smith have an existing home loan of $250,000 and a second mortgage with the same amount. Unfortunately, they have defaulted on their payment, and their collateral was sold for $450,000. In this case:
- The lender of the first mortgage will receive the initial $250,000 plus any fees incurred through interest and other expenses. All these become deducted from the sale value of $450,000.
- After refinancing the home loan, any remaining money from the sale goes to the second lender. In most cases, this is much less than that from the first lender.
Why do people take out a second mortgage?
There are many reasons why people take out another mortgage, but these three are the most common:
- Financing a big purchase
Those who have something big to spend on but don’t have the necessary funds can take out an additional mortgage. The money from the second mortgage can finance pretty much anything that the borrower needs.
- Acting as a loan guarantor
Loan guarantors serve as backup payers for a borrower. If the borrower is unable to pay, the guarantor must then shoulder the loan. This is common in parents acting as guarantors for their children’s home loans.
A guarantor uses any currently owned property as collateral for the borrower’s loan. As such, this is also considered a second mortgage by the lender in question.
- Equity access
Borrowers naturally want higher equity on their mortgages. However, lenders can sometimes reject requests for higher equity access based on funding. A second mortgage is a somewhat risky but viable option to address this issue.
What are the benefits and disadvantages of a second mortgage?
Though an additional mortgage can look risky, it does come with several benefits. These are:
- Consolidating existing debts: Debt consolidation is possibly the most significant advantage here. Any liabilities that the borrower currently has are payable this way. This is especially advantageous if the borrower has multiple existing debts.
- Savings: Those seeking to refinance current mortgages may find themselves unnecessarily spending more money due to additional fees. Instead of refinancing, a second mortgage is a viable option to save money.
- Liquidity: Access to another mortgage increases the borrower’s liquidity. This is advantageous, especially if there are big purchases that are incoming.
Some drawbacks of a second mortgage include:
- Higher fees and interest rates: This mortgage type has higher fees and interest rates due to the associated risk to the lender.
- Lender choices: Lender choices are limited in this case, also due to the higher risk associated.
- More debt: More debt means that the borrower needs to take on greater financial responsibility.
Compare Second Mortgage Offers Between Several Lenders
Not many lenders offer the option of an additional mortgage. For those that do, interest rates and fees tend to be higher. If this is the case, then it is best to go for the lender with the lowest rates.
Comparison sites like Makes Cents can help with rate and fee comparison. Go for the best option for a second mortgage today.
References:
Investopedia: Guarantor https://www.investopedia.com/terms/g/guarantor.asp
Investopedia: Second Mortgage https://www.investopedia.com/terms/s/secondmortgage.asp
Investopedia: Debt Consolidation https://www.investopedia.com/terms/d/debtconsolidation.asp
