How Do Second Mortgages Work?
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What Is a Second Mortgage?
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A standard home mortgage is a loan granted to fund the purchase of a piece of property that puts the property under a legal lien, meaning the loan must be paid back or the lender can take legal action to take possession of the property. A second mortgage is an additional loan taken out against the value of a piece of property that puts an additional lien on the property where the first mortgage takes precedence over the second in the event of foreclosure. Since the first mortgage must be cleared before the second lender can attempt to recoup losses in the event of foreclosure, the rates on second mortgages are typically higher since the lender takes on more risk.
Home Equity Loans and Lines of Credit
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For practical purposes the term second mortgage is synonymous with a home equity loan, which is a loan taken against the built-up equity in your property. (Equity is the total value of a home minus the principal owed on mortgages, loans or lines of credit.) The main difference between the two is that mortgage refers the legal lien, while loan refers to the monetary aspect of the contract. Home equity lines of credit--or HELOC, for short--also amount to a second mortgage, since they use available home equity as a mechanism to secure the loan. It should be noted that since a second mortgage involves one mortgage that is subordinate to another, a home equity loan or line of credit taken out after the first mortgage has been paid of in full might not be considered a true second mortgage.
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Dangers of Taking Out a Second Mortgage
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A second mortgage can be a useful tool for you to secure a large loan at a relatively low interest rate if you have built up a substantial amount of home equity, but tapping into home equity should always be done with extreme caution. Home equity makes up a large percentage of the net worth of most individuals in the United States, but taking out a second mortgage forfeits home equity and further drains money over time through interest payments. When seeking to build wealth, it is rarely a good idea to take loans at interest. The best use of a second mortgage is to survive sudden and unforeseen financial burdens. Foreseeable expenditures should be saved for ahead of time, which will result in more wealth in the long term by avoiding interest payments.
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