Second Mortgage Loans

Any mortgage on your home other than your primary mortgage is technically a second mortgage loan, but there are different types of loans often grouped under the heading "second mortgage." The two types of second mortgages you need to concern yourself with are traditional home equity loans or second mortgages and home equity lines of credit. Below we will go over the positives and negatives of each type of loan and touch on the general concerns that come with each loan.

Home Equity Line of Credit

A home equity line of credit or HELOC is a second mortgage on your home that is used to borrow money against your home. A home equity line of credit is a good second mortgage loan if you want to have access to credit over a period of time; the lender sets a draw period and defines how much money can be drawn out over that period. When you pay down the principle on the loan your credit reserves are regenerated in proportion. For example, let's say you have a $10,000 home equity line of credit loan. You borrow $8,000, but then pay back $5,000 towards principle; you now have access to $7,000 again. Home equity lines of credit can be good for paying down debt because the rate of interest you will pay on a HELOC will almost certainly be less than what you pay on higher interest debts like credit cards and the interest is tax deductible!

HELOC Concerns

A home equity line of credit is a great second mortgage loan if used wisely, but remember, money costs money, and with a home equity line of credit the amount that that money costs can fluctuate because HELOCs have variable interest rates. Most home equity line of credit loans have interest rates based on the shortest term interest rate of all, the Wall Street Journal prime rate. The Wall Street Journal prime rate pretty much moves in lock step with federal fund rates, which are and have been moving upward. If you can handle ups and downs (right now ups) in your monthly debt service then this will not be as much of a concern as it would for someone on a fixed income.

Second Mortgage - Traditional Home Equity Loan

A traditional second mortgage loan is a one-time cash issuance with a fixed rate to be paid back in equal installments. This is the best option if you need a specific amount of money for a particular event and not access to an undetermined amount of credit over a period of time. As with a HELOC, the interest on a traditional second is tax deductible.

Traditional Second Mortgage Concerns

It is nice that second mortgage loans come with fixed rates, however, that fixed rate is almost always higher than that of the regular 30-year fixed mortgage rate average because the loan is a second mortgage and is not first inline in the event the borrower defaults. Both with second mortgage loans and HELOCs lenders will sometimes entice borrowers into loans that are not in their best interests. For instance, a borrower with bad credit might be offered 30 year second mortgage loan to be paid back on a 15 year repayment schedule with a loan ending balloon payment. Now, that borrower would not be able to service that second mortgage debt if half the repayment balance was not rolled into the backend of the loan, and obviously that person already is having trouble with their debt so the situation could set in motion future heartbreak because the borrower's home is on the line.