Pros and Cons of Second Mortgages

Aaron Crowe
Written by
Aaron Crowe
Read Time: 2 minutes

Home may be where the heart is; but for millions of Americans, home is also where the money tree grows-a money tree known as a second mortgage.

A second mortgage is a loan drawn against the equity in your home in addition to your first mortgage. It generally takes two forms. One is the home equity line of credit, or HELOC, which works much like a credit card and allows you to draw money whenever you need it. The other kind of second mortgage is the fixed-rate home equity loan, where you receive a lump sum of money. Unlike the variable-rate HELOC, this loan's interest rate is fixed and has a set repayment schedule.

Plenty of Pros

Second mortgages have plenty of positives. To begin with, you have quick access to cash at a favorable interest rate. Lending institutions generally offer second mortgages at very good rates, depending on your credit history and the interest rate climate. And your loan payment is offset by the fact that the interest paid on mortgages may be tax deductible. Finally, since most homes appreciate in value, the equity automatically replenishes itself.

Compare a second mortgage loan, for example, with what you'd pay to borrow money on a credit card or a standard consumer loan. Rates on these funds generally approach double digits, and can be laden with service charges and hidden fees. A second mortgage is relatively inexpensive to close, and the money can be used for whatever you want-home improvements, college tuition, debt consolidation, or even a vacation.

Careful of the Cons

The biggest drawback to second mortgages is ironically also its strength. Because lending institutions are more than happy to provide you with as much home equity cash as you want, borrowers tend to tap more than they need.

This can put you in a real pickle if you decide to move or if interest rates increase. If relocating is your choice, but the real estate market gets soft and your home depreciates in value, you may wind up owing more than your house is currently worth. And if interest rates spike, you'll find interest payments on a HELOC will jump as well, straining your budget.

The bottom line with second mortgages is to watch your personal bottom line. Home equity can feel like money growing on trees; but be careful how much you prune. Take only what you need, and make sure the monthly payment works for you. If you're disciplined, you'll find the second mortgage is a lending option that bears some very tasty fruit that's second to none.

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