March 3, 2017

Settling on a Second Mortgage: What you Need to Know

What is a second mortgage?

Second mortgage definition

A second mortgage is a lien on a property that is subordinate to an existing first mortgage.

A loan to acquire a home is usually the first lien recorded on a property. Subsequent loans generally require new appraisal and the amount that can be obtained depends on the owner’s equity in the home- that is, the market value of the home less the balance of the related loan.

Homeowners may then use the proceeds of the second mortgage for whatever purpose it will have on the borrower. In many cases, home owners use proceeds to remodel or make home improvements and for many other uses.

Why do you get a second mortgage? You get a second mortgage when the interest rate and repayment schedule on your second mortgage may be more favorable than refinancing your first mortgage with a larger loan.

Moreover, the cost to obtain your second mortgage may be very small compared to refinancing with a larger loan. In some instances, the borrower does not even incur additional costs at all- there may be no closing, upfront costs to you.

To illustrate, for instance, your home is worth $300,000 and you owe $180,000 on your first mortgage. Assuming that credit score is good enough and your bank uses the 80% rule to finance the $300,000, you have $240,000.

After deducting the $180,000 first mortgage loan from the $240,000, then you may still borrow up to $60,000 on your second mortgage.

This is then recorded in the public records and becomes a lien against your home.

Second mortgage vs. HELOC

Now, a second mortgage may be structured in two terms. One, as a fixed amount to be paid off in a specific time. This is called home equity loan.

It is a fixed rate loan distributed in one lump sum, with terms ranging from five to thirty years. You pay it back in monthly installments.

Experts suggest that this type of second mortgage is appropriate if you have a one-time expense, such as wedding, a debt consolidation or a major addition to your home, or even a purchase of a new home.

Experts say that home equity loans may give you additional closing costs, although such may not be very substantial. It is also important to note that should you miss payments; your credit score will decrease. However, your loan balance does not affect your score.

Second, you may structure it like a line of credit. Actually, the second type is really a line of credit. It is called home equity line of credit or HELOC.

This is the more appropriate type of second mortgage if you need money intermittently. It is structured like a credit card.

Once your lender approves you for a maximum loan amount, you can access the money whenever you need it. You retrieve the funds with an ATM card or check.

The draw period is usually ten years, with total payment due in twenty years. Your monthly payments are variable, depending on the balance of the loan.

As you pay the money back, the funds are made available again on your line of credit. This type of second mortgage will actually provide you with renewable source of funds throughout the draw period.

This is a good option if you need to make periodic payments such as tuition, home and automobile maintenance costs, etc. Just like the home equity loan, your credit score will be on the line if you are not diligent enough to make payments. Worse, your property can go through foreclosure.

Here’s a tip from experts. Lenders do not usually grant second mortgage loans on depreciating assets. Here are some reasons for the loan that your lenders might consider:

  • Education
  • Home remodeling, additions and improvements
  • Medical emergencies
  • Reliable investments
  • Care for dependents
  • Debt consolidation
  • Bail bond security
  • Transportation

Now, how do you go through second mortgage settlement?

Second mortgage settlement is much like credit card settlement. The lender and the borrower will have to come to an agreement that the mortgage holder/lender will accept money less than the outstanding balance of the loan.

Experts say this happens when your home is “underwater” or has negative equity. That is, the market value of your home is lower than the balance of your loan.

Depending on how much negative equity exists, your second mortgage lender may lose his security interest if the first mortgage holder forecloses.

Experts thus suggest that if your home is “underwater” and you are delinquent on your second mortgage, then second mortgage settlement is a good option for you.

In such a case, it is important that you see an attorney who will help you examine your whole financial situation. If this is your situation, contact us so we can help you evaluate the options available and will guide you to take the best alternative there is.

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