What Are 2nd Home Mortgages?
Second mortgages offer homeowners a way to take advantage of their home equity for any number of reasons. Although they have become popular as a method of consolidating debt, there are risks to further encumbering a home. Because a second mortgage is lien on the home, it is subject to foreclosure even if there is no equity in the home at all.
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Secured Loan
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A second home mortgage is a secured loan secondary to another loan or lien on the property. The first mortgage is the loan first registered with the county or city, and is also called the first trust deed. A second mortgage, or second trust deed, is registered after the first. A second mortgage is secured because the equity in the home is used as collateral for the loan. It is considered a subordinate loan because if the house sells or is foreclosed, the first trust deed is paid before the second.
Equity
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A second mortgage is typically considered a home equity mortgage. Lenders look at the value of the home as well as the owner's equity before approving a second mortgage. Equity is the unencumbered value of the home. It is calculated by subtracting the outstanding balance of a mortgage from the fair market value of the house. Equity increases as the value of the home increases and as the homeowner pays down the principal balance of the mortgage. According to the Mortgage Fit website, typically, lenders will approve a second mortgage if the second mortgage and first mortgage amount to less than or equal to 85 percent of the home's value. For example, consider a home that is valued at $100,000 and has $30,000 in equity. This means that $70,000 is still owed on the first mortgage. Therefore, a lender might approve a second mortgage in the amount of $15,000, because the total amount owed on both mortgages totals $85,000, or 85 percent of the home's value.
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Types
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There are several types of second mortgages available to the homeowner. Cash out second mortgages allow the homeowner to borrow against the value of the home and receive all or part of the loan amount in cash. Debt consolidation loans are made to consolidate high-interest, unsecured loans into one, lower-interest loan with easier to manage payments. Fixed-rate and term second mortgages are available, as are variable rate home equity lines of credit.
Purpose
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Second mortgages can be used to consolidate high-interest debt from credit cards, home improvements and renovation, college tuition and to make major purchases. Interest paid on a second mortgage may be tax deductible, whereas interest paid on auto loans and credit cards is generally not deductible. Many people take out a second mortgage on their home to supplement their income or establish emergency funds, to cash out the equity in the home for investment purposes like buying an income property or for starting a business.
Considerations
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Second mortgages reduce the equity in the home and increase the cost of living in the home, because two mortgage payments must be made. In addition, in most states, some lenders will allow homeowners to borrow up to 125 percent of their home's value. This means that homeowners have a negative equity in their home; it may take them years just to get back to $0 equity. Mortgage payments must be made on time. Even though a second mortgage is subordinate to the first, the lender holding the second can foreclose on the property if payments are not made. Before taking out a second mortgage, homeowners should carefully evaluate their financial situation and be sure they can make regular, on-time payments.
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