SECOND MORTGAGES
A second mortgage is any loan that involves a second lien on the property. Some second mortgages are for a fixed dollar amount paid out at one time, in the same way as a first mortgage. As with firsts, such seconds may be fixed rate or adjustable rate.
A home equity line of credit (HELOC) is usually a second mortgage also, but instead of being paid out at one time, it is structured as a line of credit. A HELOC allows the borrower to draw an amount at any time up to some maximum. They are always adjustable rate. A line of credit is most convenient when cash needs are stretched out over time. A common example is a series of home improvements, one followed by another. Fixed-dollar seconds are best when all the money is needed at one time. Many home purchasers take out such seconds to avoid mortgage insurance on the first mortgage or the higher interest rate on a jumbo loan.
When taking a fixed-dollar second, borrowers can select between fixed and adjustable rates, as they prefer. When taking a HELOC, they take an adjustable, and if they want a fixed they can refinance into a fixed-dollar second after they have drawn as much as they intend to borrow on the line.
Second mortgages are riskier to lenders than first mortgages. In the event of default, the second mortgage lender gets repaid only if there is something left after the first lender is fully repaid. Hence, the rate will be higher on the second, provided everything else is the same. Of course, if the second mortgage is a line of credit with an adjustable rate, it may well be priced below the rate on a first mortgage with a fixed rate.
As a general rule, it is not a good idea to take out a second to pay off a first, because seconds are priced higher. If you take out a second mortgage to repay the first, the second becomes the first, which is advantageous to the lender because you are paying a second mortgage price on a first mortgage. But there is at least one exception to this rule. Borrowers with a high-rate first mortgage with a small balance may find it more advantageous to pay off the first with a second rather than refinance the first. This reflects the higher settlement costs on the first. Some borrowers lower their rate by refinancing a first with a HELOC In the process, however, they are exposing themselves to the risk of future rate increases. HELOCs are much more exposed than standard ARMs (Adjusted Rate Mortgage).
There are several things to keep in mind when considering a second mortgage:
- Lenders consider second mortgages to be much riskier than first mortgages. In the event of default, the second mortgage lender gets paid off only after the first mortgage lender is paid in full. Because of this additional risk, lenders usually charge a higher rate for second mortgages than for first mortgages. Also, such loans are commonly adjustable rate mortgages, so lenders are largely protected against inflation or changes in interest rates.
- If you are buying a home, a second mortgage can help supplement your down payment and closing costs. As long as you are able to make the proper payments, the lender shouldn't have any objections.
- If you are financing to get cash out of your property, a second mortgage or home equity loan may be cheaper than replacing your first mortgage.
- Second mortgages have shorter terms, typically ranging from 5 to 15 years. In contrast, most first mortgages have terms of 15, 25 or 30 years.
- A second mortgage in the form of a credit line can advance you cash with relatively little cost up front. In addition, the interest rate is usually far lower than you would normally pay for unsecured consumer credit.
HOME EQUITY LINES
Consumer borrowing through personal loans and credit cards is at an all-time high. Many people are buried under thousands of dollars of debt with interest rates of 18 percent or more. A new breed of mortgage lenders has created a brand new class of second mortgage products designed to help consumers get out from under their mountain of debt.
These loans are commonly called equity lines, home equity lines, home equity lines of credit (HELOCs), or debt consolidation loans. These loans have interest rates that are higher than traditional first mortgages but are usually much lower than interest rates charged on credit cards.
There are no standard loan types for these second mortgage programs. The only common feature is that all of these loans are secured by a lien on the borrower's home. Unlike credit card debt, if the borrower fails to make a payment, the lender can foreclose on his home.
Some of these loans are structured like credit card debt and can actually be accessed with credit cards or checks. Others are fixed rate, amortizing loans or balloon loans. Up until recently, some lenders were eager to loan up to 125 percent of a home's value. A CLTV (Current Loan To Value) ratio of 125 percent is unthinkable in traditional mortgage lending.
Home equity loans have several inherent features that should concern potential borrowers.
Since a home equity loan is secured with a lien on property, a borrower who defaults can be foreclosed. Consider this: A homeowner has a $20,000 credit line, becomes unemployed and for whatever reason borrows $200 on a credit line mortgage, which is not repaid. Can a lender really foreclose if the outstanding balance is only $200? Yep. Will a lender necessarily foreclose? The answer depends on the lender's policies, but in the interest of good public relations it's likely that most lenders would try to work something out before foreclosing.
A second possible problem is that some second mortgages may actually be too accessible for some borrowers. Many otherwise responsible people overextend themselves with unsecured credit card debt, so it's likely that some borrowers will do the same with secured credit lines. Currently, lenders often permit the withdrawal of relatively small sums; often less than $500.
Whether you choose to start a second mortgage or a HELOC, you need to think hard and consider all your options. One or the other won't always be the best option for your needs.
Thank You!
Ricardo Bueno | Mortgage Planner
