A second mortgage is a loan taken out to supplement your original mortgage and is also secured by your home. It can be taken out either at the same time as your original mortgage so that you can make a larger down payment and thereby avoid having to pay for mortgage insurance or later down the road in order to finance large expenses that would be difficult to obtain loans for otherwise, such as home improvements, a new car, or a child’s college tuition.
For instance second mortgages are common to pay for home improvements, purchasing a new a car, or paying for a child’s college tuition. They hope to avoid paying for mortgage insurance on their original loan. However, this type of second mortgage has become less common since the financial crisis.
Borrowers often use second mortgages because the interest rate on a second mortgage is typically cheaper than the interest on a car loan, or on a home improvement loan. Nevertheless, interest rates for second mortgages tend to be higher than those for original mortgages because the lender’s position is less secure. This is because if a borrower defaults, the funds generated by the sale of the home will go towards paying off the first mortgage, with any remaining funds paying off the second mortgage. Therefore, the second mortgage lender might not get compensated and must account for this risk with higher rates.
Second mortgages come in many forms, the two most common being a home equity loan and a home equity line of credit. The amounts of either type of loan will be determined by the equity you have in your home as well as your credit standing. Equity loans are usually lump sum payments, while equity lines of credit function like a credit card, with a maximum limit, allowing you to make charges against it as you need.
Most borrowers will have to decide between taking out a second mortgage or refinancing their original home loan. The choice will usually come down to what will cost more, and what is more affordable in the short term. Refinancing your original mortgage could provide the funds you need, but it will likely come with expensive closing costs, while taking out a second mortgage might include a higher interest rate, but could come with no upfront costs. A borrower should also consider the consequences of defaulting on a second mortgage. For example, if you use one to pay for a car, you are at risk of losing your home, while defaulting on a car loan would only cost you a car.
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