Second Mortgage 2

Definition of "Second Mortgage"

A loan with a second-priority claim against a property in the event that the borrower defaults. Second Mortgages Versus Home Equity Lines: A second mortgage is any loan that involves a second lien on the property. Some second mortgages are for a fixed dollar amount paid out at one time, in the same way as a first mortgage. As with firsts, such seconds may be fixed rate or adjustable rate. A home equity line of credit (HELOC) is usually a second mortgage also, but instead of being paid out at one time, it is structured as a line of credit. A HELOC allows the borrower to draw an amount at any time up to some maximum. They are always adjustable rate. A line of credit is most convenient when cash needs are stretched out over time. A common example is a series of home improvements, one followed by another. Fixed-dollar seconds are best when all the money is needed at one time. Many home purchasers take out such seconds to avoid mortgage insurance on the first mortgage or the higher interest rate on a jumbo loan. When taking a fixed-dollar second, borrowers can select between fixed and adjustable rates, as they prefer. When taking a HELOC, they take an adjustable, and if they want a fixed they can refinance into a fixed-dollar second after they have drawn as much as they intend to borrow on the line. Seconds Priced Higher than Firsts: Second mortgages are riskier to lenders than first mortgages. In the event of default, the second mortgage lender gets repaid only if there is something left after the first lender is fully repaid. Hence, the rate will be higher on the second, provided everything else is the same. Of course, if the second mortgage is a line of credit with an adjustable rate, it may well be priced below the rate on a first mortgage with a fixed rate. Refinancing a First with a Second: As a general rule, it is not a good idea to take out a second to pay off a first, because seconds are priced higher. If you take out a second mortgage to repay the first, the second becomes the first, which is a gift to the lender: you are paying a second mortgage price on a first mortgage. But there is at least one exception to this rule. Borrowers with a high-rate first mortgage with a small balance may find it more advantageous to pay off the first with a second rather than refinance the first. This reflects the higher settlement costs on the first. Some borrowers lower their rate by refinancing a first with a HELOC In the process, however, they are exposing themselves to the risk of future rate increases. HELOCs are much more exposed than standard ARMs. Using a Second to Avoid Jumbos: Jumbo loans are larger than the maximum size loan that Fannie Mae and Freddie Mac can purchase. In 2003, the maximum was $322,700. Jumbos carry interest rates from 1/4% to 1/2% higher than the 'conforming' loans purchased by the agencies. Borrowers who need a loan above the conforming loan maximum, but not too much above it, may save money by taking a first mortgage for the maximum and a second for the amount required above the maximum. Negative Amortization ARM May Prevent a Second Mortgage: Mortgage lenders may be unwilling to make a second mortgage loan if the first mortgage is an ARM that allows negative amortization. Second mortgage lenders assess the risk on a second by the amount of equity available to pay them. The equity equals the property value less the balance on the first mortgage. Since the loan balance on the great majority of first mortgages goes down every month, the equity available for the second rises every month. But a negative amortization ARM is a different story. On these loans, the balance can rise over time, which reduces the equity protecting the second mortgage. Some lenders will reject second mortgage applications out of hand when the first is a negative amortization ARM, without considering whether or not the equity protecting them might be adequate.

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