If you are still paying off your original mortgage, you might wonder why you would want to take on a 2nd mortgage. This might seem to be piling on yet another financial obligation, but 2nd mortgages can be a cost-effective form of financing that saves you money in the long run.
Still, any mortgage is a serious commitment, so before you pursue getting an additional mortgage on your home, it is important to understand both the characteristics of 2nd mortgages and some tips for making the right decisions about them.
What is a 2nd Mortgage?
The name might be confusing to some people, because even if you have refinanced once or twice in the past, you can still get a 2nd mortgage. In this case, the name of the mortgage does not refer to how many mortgages you might have had previously, but to the fact that the new lender has a secondary claim on your home as security against the loan, while the owner of your original mortgage still has a primary claim.
There are two important implications to this. One is that like any mortgage, this kind of loan means you are staking your home on your ability to repay the amount of money that is lent out The other is that because the lender's claim on your property is secondary to the existing lender's, the interest rate is likely to be higher than it would be for a primary mortgage.
Uses of 2nd Mortgages
2nd mortgages are a form of home equity loan, and there are some good reasons why people use this form of financing.
For one thing, a mortgage will generally carry lower interest rates than other forms of financing, such as a personal loan, car loan, or credit card debt. So, if you have to borrow, a second mortgage may be a cost-effective way of doing so.
Another reason for choosing a 2nd mortgage is that it is a way of tapping into your home equity without disrupting your existing mortgage. If that existing mortgage has more favorable terms than you could get today, there is no need to sacrifice those favorable terms on your remaining balance just to tap into a portion of your equity.
What You Should Know
While 2nd mortgages can be useful financial tools, there are some things you should know before choosing one:
- Putting your home on the line is always a serious decision. 2nd mortgages are cheaper than many other forms of financing for a reason - you are using your home as security. Think carefully about your ability to repay the loan before you make this commitment.
- Borrowing against equity can diminish your future flexibility. Reducing the equity in your home may limit your ability to refinance in the future, and it could also delay the day when you finally own your home free and clear.
- Cash-out refinancing might be an alternative. Because primary mortgages generally offer lower rates, refinancing your existing mortgage and tapping into equity via a cash-out loan might be a cheaper alternative. However, if interest rates have risen since you got your current mortgage, a 2nd mortgage might be more cost-effective because it allows you to borrow against equity without exposing your existing loan balance to an increase in rates.
- There is money to be saved by shopping around. Once you decide on a loan type, keep in mind that terms can vary greatly from one lender to another. A little time spent shopping around on the front end can save you money for years to come.
- Pay attention to fees as well as rates. Much of the discussion around shopping for a loan involves comparing rates, but don't overlook the fees involved. These can represent a significant percentage of the amount borrowed. Look at the total cost of the loan, including both interest and fees, before you borrow. This can affect your choice of lender, and it might even sway your decision about whether the loan is worth it in the first place.
Is a 2nd mortgage right for you? Choosing the right financial instrument always comes down to the specifics. Once you understand the obligations of 2nd mortgages and compare the costs with other financing alternatives, you will be in a better position to decide whether this kind of loan makes sense for your situation.