Second Mortgage - Benefits and Considerations

Opting for a second mortgage is a decision which warrants a great deal of consideration. Before entering into a second mortgage, homeowners should carefully weigh the advantages and disadvantages of taking on a second mortgage and should also carefully review the different options available. A second mortgage is often enticing because these closed-end loans can be used for any purpose and may even be tax deductible but caution should be exercised because defaulting on these loans can put the home under which the second mortgage was secured in jeopardy.

The Benefits of a Second Mortgage

We have already stressed the importance of carefully weighing the available options in deciding whether or not to take on a second mortgage. In this section we will outline the benefits of a second mortgage. Although a second mortgage may increase the amount the homeowner pays in the long run, there are other worthwhile benefits to this type of mortgage. Some of these benefits include:

· Debt consolidation

· Tax advantages

· Home improvement possibilities

· Favorable interest rates

Debt consolidation is just one of the many advantages to a second mortgage. A second mortgage is typically secured based on the equity in the home but it can often be used for any purpose. This gives homeowners the opportunity to consolidate several debts including high interest credit card debt, under the umbrella of a second mortgage. Debt consolidation can greatly increase monthly savings by allowing the homeowner to repay high interest debt at the lower interest rate associated with the second mortgage.

There are also tax advantages to securing a second mortgage. As we mentioned credit card debt and other debts may be consolidated under a second mortgage. This is beneficial because tax laws may enable the homeowner to deduct the interest on their second mortgage.

The opportunity to make improvements to the home also exists with a second mortgage. As previously mentioned, a second mortgage can be used for a variety of purposes. Many homeowners take out a home equity line of credit which enables them to cash out on the equity of their home for purposes such as home improvement.

Finally, favorable interest rates are another reason for homeowners to opt for a second mortgage. In making this decision the homeowner should calculate the cost of taking out the second mortgage and compare this cost to the long terms savings potential. If the long term savings potential exceeds the cost of the second mortgage, it is a worthwhile investment.

Types of Second Mortgages

In making the decision to take out a second mortgage there are two main options which homeowners should consider. The most popular types of second mortgage include a home equity line of credit or a closed-end second mortgage. In this section we will explain these two options.

A home equity line of credit is essentially a revolving line of credit which enables the homeowner to take advantage of the equity in his home. The maximum amount for this credit line is usually based on a percentage of the appraisal value, usually 75%-85%, of the home minus the balance remaining on the original mortgage. Home equity loans are ideal for homeowners who wish to have a revolving credit line at their disposal and who are secure in using their home as collateral in securing this loan.

The significant difference between a closed-end second mortgage and a home equity line of credit is the closed-end mortgage offers a fixed loan amount to be repaid over a fixed amount of time while the homeowners can withdraw additional funds from the home equity line of credit whenever there is existing equity in the home. The closed-end second mortgage is ideal for homeowners with a one time specific need for funds.

Considerations before Taking on a Second Mortgage

We have discussed the benefits of a second mortgage and the types of mortgages available but homeowners should also evaluate the risks of taking out a second mortgage. Some of these risks include:

· Losing the home if the second mortgage is not repaid

· The costs of taking out a second mortgage

· Prepayment penalties

Perhaps one of the greatest risks of a second mortgage is the threat of losing the home if the mortgage is not repaid in a timely fashion. It is important to remember the collateral for a second mortgage is often the home itself. Becoming default on the second mortgage can result in loss of the home.

There are certain expenses associated with taking out a second mortgage. These costs may include application fee, loan origination fees, appraisal fee, survey costs, home inspection fees, title fees, homeowner's insurance and mortgage insurance. These fees could be equal to 3%-10% of the outstanding principal on the first mortgage. Before investing in a second mortgage, the homeowner should ensure the overall cost savings of the second mortgage will exceed the fees associated with taking out the second mortgage.

Finally, prepayment penalties should be thoroughly examined before taking out a second mortgage. This involves charging the homeowner for repaying the second mortgage ahead of schedule. Homeowners who intend to repay the second mortgage should ensure the lender will not charge prepayment penalties or should evaluate whether or not the penalties will be worthwhile.