Second Mortgage

It is interesting to note that most home owners become jittery when ever the issue of arranging a second mortgage against their assets come up for discussion. This is simply owing to the reason that most home owners perceive having a second mortgage for their property as inviting a financial debacle or view it as an undisputable indication of bankruptcy.

Nonetheless, the fact remains that although the home owners or people wanting to buy new homes may not find themselves at ease with more than one mortgage against their property, a greater number of unresolved unpaid mortgages or credits actually do not affect the financial security of any person. On the contrary, what is of concern is the total amount of money that has been taken on loan by an individual when evaluated against it reasonable worth in the market. Putting this in other words, it is important to assess how much stake or equity the home owner still holds over his or her property.

For instance, on the basis of a reasonable market value of $150,000, a home owner's equity on his or her property is $30,000 and he or she may have one mortgage worth $120,000, two mortgages valuing $80,000 and $40,000 or even three credits worth $60,000, $40,000 and $20,000 listed against the ownership of the property. In all these instances, the home owner's stake on his or her property will be only 20 per cent, while the major chunk of the equity, i.e. 80 per cent, will be controlled by other people. In terms of money value, the first part of $120,000 is controlled by one or more lenders or mortgagee, while the borrower owns the remaining $30,000.

It may be mentioned here that the rate of interest that the borrower or home owner requires to disburse on the second mortgage will be determined by his or her equity hold on the property. Supposing, the total amount taken on loan in both the first and the second mortgages does not surpass 75 per cent of the assessed value of the property, the second mortgage will also considered to be secure as the first mortgage, if one really exists, and the rate of interest payable on the second mortgage will manifest this aspect. However, if the home owner's equity hold on his or her property is below 25 per cent, the borrower will be required to pay a very high rate of interest on the second mortgage. The exact rate of interest will be determined on the security of the loan, the mortgage agreement as well as the lender. This will be necessary to manifest the extra risk on the investor's mortgage money.

In fact, it is always more unsafe for any lender to invest in a second mortgage as the borrower is already burdened with a first mortgage and may be a defaulter in the second case. However, here we are only concerned about the borrower and hence will not discuss the lender's point of view in detail. Getting back to the topic, obtaining a second mortgage can be of great benefit to the home owner as it is an effectual method to lessen the exorbitant interest expenses that are related to residential mortgages. The second mortgage can be of greater importance if a home owner already has a mortgage and still wants some money on loan for a specific agenda.

Suppose, two years back, a home owner has taken a mortgage worth $100,000 at an interest rate of eight per cent with the pledge to repay $763.21 every month. Currently, the outstanding amount to the mortgagee is $97,218.57 and the home owner wants to take a fresh loan of another $27,781.43 taking his total loan dues to $125,000. The home owner now wants to borrow again with a view to undertake some changes in his or her home as well as redecoration by organizing a home equity credit. In such a situation, the home owner has two alternatives to choose from. In the first instance, the home owner may organize a single new mortgage worth $125,000 or opt for a second mortgage valuing $27,781.43.

As mentioned earlier, the interest rates for the second interest are always higher than the first mortgage. In this instance, the interest charges cited on the two alternatives - eight per cent for arranging a single mortgage worth $125,000 and 11 per cent on the second mortgage valued at $27,781.43. Going by these rates, most people will take it for granted obtaining a new first mortgage worth $125,000 would relatively be more economical. However, before coming to any such conclusion, the borrower needs to find out whether making a payment before the due time for the old first mortgage will make him or her also shell out a considerable amount as a fine or penalty. Here, it is significant to note that if the borrower does not change the lender and seeks the new first mortgage from the lender of the first old mortgage, he or she will not have to pay any fine while making the prepayment on the old mortgage. This is because; the lender will simply be providing additional loans on the same property. While this may seem to be profitable for the borrowers or home owners, actually it is not all that lucrative as they are compelled to remain with the same lender and not avail the opportunity to take advantage of any other lender's competitive terms and interest charges.

Talking about the interest figures, if a home owner arranges the new first mortgage worth $125,000 at an eight per cent interest rate with the facility to amortize (the option to lessen the liabilities by repaying the principal amount and interest charges in installments) for a period of 23 years, as two years on the original first mortgage has already lapsed, he or she would require to pay an extra amount on the additional loan of $27,781.43. In this case, the home owner or borrower will need to pay $32,412.66 for borrowing the additional amount of $27,781.43. This is owing to the increase in the payments made every month from $763.21 to $981.31.

Although it may appear to be incredible, despite the fact that the interest rates of nearly all second mortgages are usually at a minimum three per cent more compared to the first mortgage and are worked out on a monthly payment basis, often opting for a second mortgage may turn out to be more profitable for the borrower. If the supplementary $27,781.43 is funded through a second mortgage at an interest rate of 11 per cent worked out for every month or 11.2552 per cent twice a year with a provision to amortize the loan over a period of 10 years, the cumulative interest expenditure on the mortgage will turn out to be $18,141.20. This means that despite the higher interest charges on the second mortgage, the borrower will make a saving of more than $14,000.

Many people may argue that when the amortization (reduction of debt by paying installments) in the instance of the second mortgage is only for 10 years instead of 23 years in the case of the second first mortgage and the amount to be paid for the additional loan of $27,781.43 is as high as $382.69 every month - substantially more than the extra monthly payment required for the second first mortgage, how can a borrower gain from such an arrangement, the second mortgage plan. The differences truly manifest the truth, but it must also be borne in mind that most of the time, the home owners obtain a second mortgage for some explicit cause and owing to the high expenses involved in the instance of a second mortgage, the borrowers would like to clear of the debt at the earliest. And the decision to opt for a second mortgage makes this possible as it offers a smaller amortization period. It may, thus, be concluded that the alternative of a second mortgage enables the home owners to pay off their loan liabilities sooner. In addition, taken as a whole the expenses incurred in a second mortgage are much less compared to refunding first mortgage.

In addition to the above, there is another pertinent reason for home owners or borrowers who already have a first mortgage with a low interest fee, to consider the option for a second mortgage while seeking additional funds. By opting for a second mortgage they will continue to enjoy the benefits of low interest rate on the first mortgage as they will not have to renegotiate with the lender and settle for a relatively higher rate to refinance their first mortgage. In this case, the combined yearly interest rates for the first and second mortgages will be much less than the prevailing rates in the market.

Here is a case in point. Supposing a home owner already has a first mortgage worth $100,000 at an eight per cent interest rate and requires more funds worth $25,000. The prevailing interest rate is approximately 10 per cent and the lender has made the borrower an offer of 13 per cent interest rate for the second mortgage. In order to work out the rough mean interest fees for a first and second mortgage, consider the part of both loans is of the sum, multiply the fraction with the interest charge for that particular credit and add the outcome collectively. The calculations are exemplified below for better understanding of the issue.

First mortgage: $100,000/ $125,000 X 8% = 6.4%
Second mortgage: $25,000/ $125,000 X 13% = 2.6%

If you add up the interest rates of both the first and second mortgage, you will find that the sum interest charges add up to nine per cent. Hence, it is amply clear that if the home owner or borrower opts for the second mortgage at an interest rate of 13 per cent and works out the mean interest charge, he will definitely benefit from the deal as if he or she goes for the refinancing of their first mortgage at an interest rate of 10 per cent, they will be derived of the eight per cent interest rate of the first mortgage that is much less than the prevailing rate in the market.

It may be mentioned here that in the instance of organizing a second mortgage, it is essential that the full and final payment for the second mortgage should be due before or at the same time of the on hand first mortgage. In such an instance, the borrower is able to avail the utmost suppleness on the loans as both the credits become eligible for refinancing jointly or independently depending on which of these two are more inexpensive. In such a situation where this is not feasible to refund the first and the second mortgages either together or separately, it is important that the contract for the second mortgage encloses a rescheduling or postponement section enabling the borrower to restore or substitute the prevailing first mortgage devoid of any problem. If this is not done, it is possible that the lender of the second mortgage may thwart the home owner or borrower from initiating any action vis-à-vis his or her first mortgage if not the second investor is also reimbursed the full and final due on the mortgage simultaneously. Alternatively, the second mortgagee may be compensated with an additional amount for the outstanding amount of the second mortgage on precedence.

Second mortgages are also of great help in the instance of a person willing to buy a new home has less than 25 per cent of the sale value of the property. As it has been mentioned earlier, an insurance premium is charge on a mortgage when the credit is said to be 'high ratio' - when more than 75 per cent of the assessed value of the property has been sanctioned as loan, on the total mortgage amount and not just the amount surpassing the 75 per cent ceiling. A borrower may think of getting a traditional first mortgage for only 75 per cent of the property procurement cost if he or she just falls short of the required equity ownership of the property and has a really sound legal agreement. In such a situation the borrower will not be required to pay any insurance charge as the mortgage will now cease to be 'high ratio'.

Here is a word of caution. Remember, the outward show of anything, particularly in the case of a second mortgage, may be misleading. Hence, before you reject the option of a second mortgage, carefully evaluate the expenses of a 'high ratio' mortgage that makes insurance payment essential with the price of a traditional mortgage and also a minor second mortgage. This will enable you to make the correct selection depending on either of these will help you to bank more funds.

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