Be Wary of the Scary in Second Mortgages

During Halloween, everything spooky becomes kooky. From phony vampire blood, to skeletons trick or treating at your door, nothing is particularly scary on one day of the year – the 31st of October. The opposite, however, can be said about second mortgage loans every day of the year. While they don’t look dangerous on the outside, frightening things lurk below their non-menacing exterior.

What’s a second mortgage?
   
A second mortgage is a loan that you take out against the outstanding equity in your property, but it’s subordinate to your first mortgage loan. There are two types: a home equity loan, or a home equity line of credit (HELOC). With a home equity loan, you receive a lump sum, which has a fixed rate and is payable on a fixed schedule. With a HELOC, you receive a line of credit with an adjustable rate, and you pay interest only on the amount of money that you withdraw.
   
Dangers lurking within

While it sounds simple enough, a second mortgage can get you into heaps of trouble if you’re not aware of the dangers. Here are some scary traps that could cause even a vampire to lose his coffin if he’s not careful.

     1. Choosing the wrong type. It’s important to understand the differences between the two types of second mortgages. If you know the exact amount of money you want to withdraw, and prefer the stability of a steady monthly payment, a home equity loan is right for you. If you want flexibility, and can endure the risk of fluctuating monthly payments, a HELOC is the better choice.

     2.  You can lose your home. A second mortgage is secured against your property. If you miss payments, your lender can foreclose, and you could lose your dwelling.

     3.  Adjustable rate. With interest rates at historical lows, people have forgotten the days when mortgage rates could cause even a mummy to die of shock. From 1978 to 1990, interest rates were solidly in double digits, reaching a high just north of 18 percent in October 1981. If your rate is adjustable, be sure that you can handle the worst-case scenario.

     4. Balloon payment. Many HELOCs require that you pay only interest during the draw period. That could mean a huge balloon payment will be due when the draw term is up, and you’ll need to pay off or refinance the balance.

     5. Late payments. Falling behind can trigger hefty fees and have a negative impact on your credit score.

     6. Reduced equity.  The more you tap your home equity, the less equity you’ll have to tap in the future if you run into financial trouble.

     7. Higher interest rates.  You’ll pay more for a second mortgage than you would for a primary loan or a refinance. The reason? The lender is taking on a higher risk because he’s subordinate to the first mortgage lien holder.

Second mortgages have a dark side. But if you become familiar with these home equity loans, you’ll protect your residence from transforming into a house of horrors.