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2nd Mortgage Loans – Extra Cash, Extra Risk?
A 2nd mortgage allows a homeowner to access the equity in their home. This is the appraised value of the property minus the amount of the first mortgage. Traditionally, second mortgages were used to finance improvements.
Homeowners can remodel the kitchen, add a deck, or finish the basement to provide a family room or home theater. The capital was used to send students to college or to provide start-up capital for a small business. The second loan for most homeowners was a one-time loan to cover a specific purpose.
Twenty years ago, only the most creditworthy people could qualify for a second mortgage which, added to the first mortgage, totaled more than 80% of the value of a house. When mortgage interest rates fell in the early 2000s, second mortgages became more common. A contributing factor has been the housing bubble which has driven home prices up double digits every year in many parts of the country.
Major financial institutions began easing underwriting restrictions on second mortgages in the 1990s, and by 2001 a homeowner could leverage 100% of their home’s value with a second mortgage. Low interest rates were attractive to homeowners. It is common for those living beyond their means to consolidate their debt with a second mortgage on their home by refinancing the second mortgage year after year.
In the past, you could expect a 2nd mortgage to be at a higher interest rate than the first mortgage on a property. Variable rate second mortgage liens have been offered with initial interest rates as low as 3%. Some homeowners have started using their home equity as a mini-bank. They would take out a second 10-year mortgage to pay off credit card debt, and their monthly payments on the new loan would be significantly lower than payments made on high-interest credit cards.
However, it is important to realize that when you take out a second mortgage on your personal residence, you are in a position of increased risk. Almost all second mortgages have a cross default policy. This means that failure to pay the second loan will cause the first mortgage to default and you risk losing the home to foreclosure. In today’s economy, rapidly declining home values mean that thousands of homeowners now have first and second mortgages well above the market value of their homes.
Equity in your home is like having emergency money in a bank account. Homeowners who view the cash generated from such a loan as an excuse for a shopping spree may struggle to keep their home. Used wisely, a second mortgage is an option available to pay for medical bills, school fees or to improve your property. Used improperly, homeowners can find themselves facing the total loss of their home. As such, you need to weigh the extra money you generate with the extra risk you’ll be taking on before deciding to take out a second mortgage for your home.
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