Should You Really Take Out a Second Mortgage?

The difference between a first and second mortgage is simple. A first mortgage is taken out for the purchase of the home, while a second mortgage is taken out on any residual value between the outstanding loan balance and the value of the house.

Second mortgages are usually obtained to perform some substantial improvement to the home, but frequently homeowners decide to use the increased equity in their home to take out a second mortgage and pay down consumer debt.

The only time it really makes sense to take out a second mortgage for home improvement is if the improvement is going to add to the value of the home. There are some projects that are considered more valuable in the eyes of homebuyers, such as additional bedrooms or a remodeled ktchen, that will make them willing to pay more for the home.

Certain luxury home improvements, such as an in ground pool, may not be as attractive to potential buyers, and would therefore not be considered a good reason for a second mortgage.

Reducing high interest rate debt is another good use for a second mortgage, as long as you are able to keep your total costs down. Typically the interest rate on credit cards can be 16 to 20% or more, while a second mortgage can be obtained at 5-9%, representing a significant overall savings to the homeowner.

Creating more debt that is not going to either add value to your home, or reduce your present high interest debt is not a good economic decision.

Second mortgages are exactly that in actuality as well as in name, since they are paid down after the first home loan is paid, and the lender has to hope there is equity to cover it.

For this reason, rates on second loans are higher because the bank has that risk, and the chance of default is higher.

There are closing fees associated with all mortgages, but the closing fees for second mortgages tend to be higher than for first mortgages. Be aware of all of the costs so that you can compare it to the benefit you plan to receive (the amount of increased home value, or the savings on credit card debt.)

Since a first mortgage is for a substantial portion of the value of the home, it is for a greater amount than a second mortgage, so the closing costs are spread over a greater amount. The effect of the closing costs on a smaller second mortgage can be significant. It is also important to shop around for a second mortgage since rates on these mortgages can be very different from bank to bank.

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