Second Mortgages - Potential Hazards to Your Financial Health

Second mortgages can be a convenient tool for borrowing money, but they can also jeopardize your personal finances because your home is used as collateral. Use them cautiously to avoid unwanted consequences, including the loss of your own house through foreclosure.

Most people buy their homes using a new loan, or first mortgage, which is secured against the property in case the borrower defaults. If you later take out another mortgage before that first mortgage is paid off, the second loan is called a second mortgage. This loan has a second priority, or second place claim, against the property since the first mortgage is already in place.

Just by understanding this definition, you may be able to imagine the potential for financial problems, especially if you've ever loaned someone money, and then loaned them some more before they paid you back. Piling one loan on top of another can lead to trouble. One of the easiest ways to overextend yourself financially is through a second mortgage.

Dire consequences

Recently, the American public seems to have thrown financial caution to the wind, and the consequences are dire. Americans are falling behind on consumer debt, including second mortgages, at the highest rate since 2001, according to the American Bankers Association. Millions of homeowners now face imminent foreclosure because they've tapped out their credit and continued to "borrow from Peter to pay Paul."

During the recent housing boom, second mortgages gave homeowners an easy source of cash, as real estate values skyrocketed. Rather than sell their homes to capture the added value, homeowners took out second mortgages. The value of their homes kept going up, so they continued to take out more loans, skimming their equity on a routine basis. Homes became great big ATM machines, with consumers making withdrawals to pay for everything from weekend homes to expensive vacations. The strategy seemed to work, and created instant millionaires with rock star lifestyles-at least on paper. But then the paper house of cards collapsed.

Second mortgages all fall down

First, the real estate market crashed, which caused the value of homes to plummet, along with their equity. Interest rates spiked, making mortgage payments higher. Consumers rushed to the bank, but lenders-faced with huge inventories of bad loans-tightened their purse strings. While all of this was happening, the credit card bills and car payments kept piling up, and gas prices went berserk.

Instead of protecting their homes, today's consumers are more inclined to pay their credit cards first in order to continue a comfortable standard of living. But they're surprised when, within 30 days of missing a mortgage payment, the foreclosure notices begin to arrive, and the wolf is howling at the door.

To avoid this scenario, approach second mortgages with deliberation and caution. They can be a great way to borrow, but not if it costs you your home.