There is not a great deal of difference between first and second mortgages except that one is normally taken out when a home is bought, and the second is taken out on the remaining balance of the first home loan.
The two most common uses that most people put a second mortgage to are home renovation and debt elimination. Both of these uses can make good economic sense if handled properly.
The only time it really makes sense to take out a second mortgage for home improvement is if the project is going to add to the value of the home. There are some projects that are considered more valuable in the eyes of homebuyers, such as extra bedrooms or a remodeled ktchen, that will make them willing to pay more for the home.
If a home improvement you are thinking about is really nothing more than a luxury, for example a pool, you most likely won’t get you money back on it.
Today, it is considered a wise financial move to reduce or eliminate high consumer debt and replace it with lower rate debt taken from the elevated value of the home. Typically the interest rate on credit cards can be 16 to 20% or more, while a second mortgage can be obtained at 5-9%, representing a substantial overall savings to the homeowner.
But be careful to use the loan for its intended purpose, and don’t “forget” to pay down those expensive credit card loans.
Unlike a first mortgage, a second mortgage will not have priority on your home if you default. The first mortgage on your property would be repaid by your home’s value before any money goes toward the second mortgage.
This is the reason that rates on second mortgages are higher than on first. The bank that holds the second mortgage risks that the proceeds of the home in case of default will not be enough to cover the loan. Since risk is one of the most important determinants of rates, this higher risk raises the rate.
There are closing costs with second mortgages just as there are with first mortgages. Make sure you are fully aware of all of the closing costs you will have to pay for loan, so that you can be sure the total cost of the loan balances the increased value of the home or the savings on the credit cards!
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 greater amount. The effect of the closing costs on a smaller second mortgage can be significant. 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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