How to Decide If You Want to Take Out a Second Mortgage

Written By: Steven S. Bayless on September 25, 2009 No Comment

by Steven S. Bayless

First mortgages are taken out when a home is first purchased, while second mortgages are taken out some time later, when the equity in the house has grown. Therefore, the purpose of the second mortgage is not to finance the purchase of the home.

Second mortgages are usually obtained to perform some substantial improvement to the home, but frequently homeowners decide to use the increased equity in their home to take out a second mortgage and pay down consumer debt.

A home renovation is a good reason to take out a second mortgage, but you should make sure that the improvements you make are going to perform are worth the additional payments you will be making.

Taking out a second mortgage to install an in ground pool may not be the best use for the funds, since a pool may not necessarily add to the value of a home.

Today, it is considered a smart financial move to reduce or eliminate high consumer debt and replace it with lower rate debt taken from the increased value of the home. Typically, a homeowner would be interested in paying down consumer debt, such as credit card debt that may have interest rates of 16-20% with the proceeds from a second mortgage, which may have a rate of 5-9%.

But be sure you use the loan for its intended purpose, and don’t “forget” to pay down those expensive credit card loans.

If a homeowner defaults on his home, the first mortgage will be paid off from the proceeds of the property. The second mortgage is not paid unless there are funds still left after the first mortgage is paid.

For this reason, rates on second loans are higher because the bank has that risk, and the chance of default is higher.

There are closing fees associated with all mortgages, but the closing fees for second mortgages are typically higher than for first mortgages. Be aware of all of the costs so that you can compare it to the benefit you plan to receive (the amount of increased home value, or the savings on credit card debt.)

Since a first mortgage is for a substantial portion of the value of the home, it is for a greater amount than a second mortgage, so the closing costs are spread over a larger amount. The effect of the closing costs on a smaller second mortgage can be substantial. It is also important to shop around for a second mortgage since rates on these mortgages can be very different from bank to bank.

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