What to Know Before Getting Second Mortgage Loans

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Many people use second mortgage loans to finance large purchases after they have built up equity in their home. A second mortgage uses the equity you have in your home as collateral for a line of credit; basically, it is another lien against the deed to your home. Second mortgages are generally flexible, meaning they can be allocated to a variety of purchases. Loan terms vary from one to thirty years. Despite these many benefits, second mortgage loans are highly risky.

A Second Mortgage is Subordinate
A subordinate loan is not listed as the primary lien on your collateral. This means in the case of a bankruptcy, your primary lien holder would be paid off before your subordinate lien holder. Even though you are securing your second mortgage against an asset, because this is a subordinate loan form, the interest rate will be very high. There is little assurance against default for the lender. They will not likely recoup funds if you default. Whenever a loan poses this type of risk to the lender, the cost of financing is much higher for the borrower. You may find lower interest rates if you secure the loan with another form of collateral, such as an automobile, and list the lender as the primary lien holder.

A Second Mortgage is Like a Home Equity Loan
Many people confuse second mortgages with home equity loans. The two are similar in the benefits they pose to you. However, the main difference is a second mortgage actually puts a lien on your home deed. A home equity loan is a line of credit or installment loan based on the assets you have in your home; but a home equity loan does not truly collateralize the deed to your home. Because a second mortgage actually places the entire value of the home as collateral, it is much riskier for a borrower. Typically assuming more risk as a borrower will drop your interest rate. In this case, your interest rate will still be high. This lessens the benefits to a second mortgage substantially when compared to a home equity loan. Some still opt for the second mortgage, though, because their credit is not high enough to get a home equity loan.

Default can Lead to Foreclosure
One thing borrowers often misunderstand about second mortgages is the fact they can lead to foreclosures on a primary mortgage. Many feel they are protected from foreclosure if they default on a second mortgage. After all, the primary lender still technically holds the deed to the home, not the borrower. The subordinate lender can purchase your primary debt, effectively buying the deed to your home from your primary lender. Then, a subordinate lender can take you through the foreclosure process in order to recover funds lost in your default. This is the greatest risk of a second mortgage, and is what ultimately can leave many people and families in desperate situations if they over-mortgage their homes, taking on too much debt, with a second mortgage.