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Second Mortgage
What to Watch Out for with a Second Mortgage
A second mortgage is a loan tool that borrows against established equity in a property. In many regards it is like a home equity loan. Like the first mortgage on a home a second mortgage can be either fixed rate or adjustable. The major difference between the first mortgage and second mortgage is that in the event of a default (bankruptcy, foreclosure, etc.) the second mortgage doesn't receive any money until the first mortgage is completely paid off. Thus, a second mortgage bears more risk to lenders and, in turn, a higher interest rate is charged. Usually, the proceeds from a second mortgage are used for home improvements and updates, college tuition, medical expenses or some other major life event but it is not limited to such.
Costs to Watch Out For on a Second MortgageJust like a first mortgage a second mortgage has various costs associated with it (maybe even a little more). In addition to the APR these can include appraisal fees, points, application fees, closing costs and title searches. In many cases these costs can be built into the second mortgage but it's necessary to talk to multiple lenders to get a better understanding of what these costs should be. One of the most important costs to be wary of is the APR. The interest you pay on your second mortgage will determine, in large part, what your payment is. If you have a fixed rate second mortgage your payment has been predetermined. If you have an adjustable rate second mortgage you'll want to make sure you know what the adjustment period is, the interest rate cap, the margin and the index that will be used to calculate your interest rate (see Adjustable Rate Mortgages for more info.).
Other Things to Watch For on a Second MortgageSecond mortgages operate much like a first mortgage but may include some extra functions that could cause problems if attention isn't paid to them. Before closing on a second mortgage be sure to ask about default penalties, prepayment penalties and balloon payments. Default penalties are much like credit card default penalties but can have a much more severe effect. This can occur in the event of a late or missed payment. Prepayment penalties are a lenders way of making money even if you don't keep the mortgage for the entire term. Ideally, you want to have no prepayment penalty in case you need to refinance or sell the home. A balloon payment is definitely something that needs to watched out for. Often lenders will try to entice a borrower with a ridiculously low payment at first and one large payment due at the end of the loan. In most cases borrowers aren't prepared for the final lump sum payment and get into trouble. Always keep in mind that if it sounds too good to be true then it probably is.