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Second Mortgage: How it works

By Demir Caner

Second mortgage is a secured loan that is subordinate to first loan against the same property. More specifically speaking it is the 'second loan' in sequence.

In real estate, a property can have multiple loans against it. The loan, which is registered with county or city registry, first is called the first mortgage. The loan registered second is called the second mortgage. A property can have a third or even fourth mortgage, but those are not common.

If mortgage loan goes into default, the first mortgage gets paid off before the second mortgage gets any money. Thus, second mortgages are riskier for the lender, who generally charges a higher interest rate. Rates and other charges might be greatly differentiated. That is why refinancing second mortgage requires more research.

Generally speaking, you may get second mortgage in two ways: First, you may own a home with equity. Second, you may get it while you are buying your home.

Second Mortgage as Home Equity Loan

The maximum amount of money that can be borrowed as second mortgage is determined by various factors, including credit history, income, and the appraised value of the home etc. It is common to be able to borrow up to 100% of the appraised value of the home, less any liens, although there are lenders that will go above 100% when doing over-equity loans.

Second Mortgage and First Mortgage Together

In some instances you may want to get second mortgage while buying your home. This is also called 80/20, 85/15 loan or 100% financing. It gives you ability to buy a home with almost no-money down. If you have a strong credit profile but have limited funds to commit to a down payment, 80/20 mortgages might be right for you. Lenders typically require a down payment of at least, 3 to 20 percent of the purchase price. If the mortgage loan amount is for more than 80 percent of the purchase price, private mortgage insurance (or PMI) is usually required.

You can avoid paying PMI by getting a second mortgage (piggyback loan) to back up your first mortgage. The first mortgage is provided for 80 percent of the cost of the mortgage and the 'piggyback' second mortgage is for the remaining 20 percent. The 80 percent first mortgage can be a fixed-rate (15-years or 30-years), adjustable-rate (usually 5/1, 7/1 or 10/1 fixed period ARM) or interest-only loan.

The 20 percent second mortgage can be a home equity line of credit that changes with the prime rate. Combined, the two loans allow you to purchase 100% of your home with no money down.

Second Mortgage Rates

For the reasons explained in above paragraph, second mortgage rates are higher then first mortgage rates. If you have a fixed rate second mortgage loan, the interest rate is set for the life of the loan. Many companies offer also variable rate second mortgages, also known as adjustable rate mortgages or ARMs. These provide for periodic interest-rate adjustments. If you have adjustable rate this allows the lender to adjust or change the interest rate. These interest changes should have upper and lower limits, as well as ‘caps’. Be sure you understand your rights and obligations before you make your decision.

Factors to Consider before getting a Second Mortgage

1. The length of your second mortgage - when is repayment of the loan required?

2. Look at payment calculations -- how much will your monthly payments cost and what will that cover?

3. Look at all of the costs associated with getting a second mortgage.

4. Check what kind and amounts of additional fees required for getting a second mortgage. (Percentage, or points, or flat fees).

5. What is the interest rate?

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