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Second mortgage interest rates are usually higher than first mortgage rates for a number of different reasons. The primary reason is that a second mortgage loan is subordinate to the first mortgage loan, meaning there is more risk to the second mortgage lender. If the borrower has to default on the home, the first mortgage takes priority when the home goes into foreclosure. The second mortgage lender may end up not receiving any or all of their loan proceeds back after the home is sold in foreclosure, so they help to offset this risk by charging a higher rate of interest. There are other reasons as well, which can depend on the lender’s strategy and profitability goals.
1. The Lender May Choose to Keep a Second Mortgage In House
Most first mortgages are sold by the originating lender to a buyer on the secondary market, and many second mortgage lenders will sell their loans as well. Those that choose to retain possession of their second mortgage loan instead of packaging it for sale on the secondary market charge a higher interest rate to offset the cost of keeping the loan in house.
The higher rate also helps to compensate for not only the second lien position, but for the additional risk incurred from not selling the loan to another party. The lender does have the option of selling the second mortgage later on, if they are able to find a counterparty willing to buy the loan. If the counterparty chooses to review the borrower’s creditworthiness and ability to repay, they may not buy the loan if there have been changes that now cause the borrower to be a high risk.
2. A Second Mortgage Does Not Earn the Lender As Much Interest
Since most second mortgages are for a shorter term than a first mortgage, the amount of the finance charges paid by the borrower is less. The second mortgage lender charges a higher rate in order to maximize their profitability on the loan.
Also if the second mortgage loan is an adjustable rate mortgage, or ARM, the lender is not able to accurately calculate the amount of interest they will make. This is due to the fact that the rate can either go up or down at each adjustment point.
3. A Second Mortgage May Be Needed to Make Repairs to the Property
A second mortgage loan used for a home that is need of repair may signal that there are more problems ahead later on as the property continues to age. The second mortgage lender can partially offset this possible future risk by charging a higher rate of interest.
If the second mortgage loan is interest only, or is a balloon mortgage, the lender has to take the chance that they may not receive all of their proceeds back should the borrower’s financial situation change when the time comes to refinance the loan.
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