Is A Second Mortgage The Right Choice For You?

Many people have chosen to take out a second mortgage for a variety of reasons. Some want to invest in a business opportunity and need capital to do so. Others need to pay down other debts. Still others need money to start a major home improvement project that will ultimately add value to their homes. In some cases, these decisions can  be financially-sound. However, these decisions can also lead to financial  difficulty.

First, it is important to understand the basics of a second mortgage. 

What Is A Second Mortgage?

A second mortgage is a subordinate loan against a property. That is, in  the event that the loan is defaulted upon, the second mortgage can only be paid once the first, or senior, mortgage is paid. Because of this dynamic, a lender assumes more risk in underwriting a second mortgage. As a result, the lender will typically charge a higher interest rate to underwrite the second mortgage.

What Are The Benefits Of A Second Mortgage?

If you have a good credit history, you can often get a favorable interest rate for your second mortgage loan. Further, your monthly payment on the loan is tax-deductible. This tax advantage can impact your decision to take out a second loan. Add to this that homes and properties on which second mortgages are underwritten typically increase in value. The increase of equity in the property can help offset the money owed on the loan.

Are There Any Pitfalls To A Second Mortgage?

Lending institutions are often happy to underwrite a second mortgage on  the equity of a home or property. So happy, in fact, that they may want to loan more money to you than you actually need. On the surface, this does not seem very risky. However, if you decide to move and home prices decrease, you may find yourself owing more money than your house is actually worth. Further, if interest rates increase, you may find  find your payments on the interest increase as well for home equity lines of credit.

When Is A Second Mortgage A Good Decision?

When you owe money on other forms of debt such as credit cards or other consumer loans, you may be paying on debt with interest rates as high  as 20%. A second mortgage loan generally carries an interest rate that can be as low as half that amount. Also, second mortgages are relatively easy to close and are usually not bloated with the hidden fees and service charges that many credit cards have.

For example, assume you owe $30,000 in credit card debt. Your credit card carries an annual interest rate of 20%. There may also be a few hidden fees and service charges that can surprise you while you pay off your credit card. You can opt to borrow $30,000 through a second mortgage loan. If the interest rate on your second mortgage is 10%, you are, in effect, saving  roughly $3,000 in annual interest payments alone. Though this is an overly-simplistic example, it does illustrate how a second mortgage loan can be used to pay off higher interest rate debt.

If you are considering taking out a second mortgage loan, the best thing you can do is understand the pros and cons behind your decision. Try to figure out the numbers behind the loan before making your decision. Use a spreadsheet if possible, so you can see the interest payments of a second mortgage and any other debt you may be carrying over time. That is the only way you can know for certain whether a second mortgage is the right decision for your needs.