A scholar second mortgage definition would go something like: a loan with a second-priority claim against a property in the event that the borrower defaults.
But that’s too stiff, right? Let’s try an easier route to understand second mortgage definition.
A second mortgage is an additional loan that is made after you’ve already done your initial mortgage to buy a house. Say homeowner Gary gets a mortgage to pay off his new home. With each payment he does to the mortgage company, he acquires a little bit of home equity, right? So, 5 years later, he needs money to pay for home renovations or college tuition for his son or unforeseen medical expenses and decides to get that equity and put it as real estate collateral for a new loan. This action of securing a loan through the loan you are still paying for is called the second mortgage.
The risk of the second mortgage to a lender is higher because, although it works the same when the borrower defaults and the lender can put the house in foreclosure to retrieve the money invested, the second mortgage is a debt with a subordinate claim to the first mortgage. All subsequent lien is, in turn, subordinate to the second mortgage, and may be used to reduce the amount of a cash down payment or in refinancing to obtain cash for some purpose. The interest rate on the second mortgage is higher because it usually has a repayment term much shorter than the first mortgage with a fixed amortization schedule.
A great benefit of a second mortgage is definitely the amount you get to borrow since the loan is secured by your home. That’s why home renovations one can do out of their own pockets are actions that always pays off for a homeowner; the more you invest in your home and make it worth more will translate into your pockets when you do a second mortgage, since lenders sometimes can borrow up to 80% of their home value!
But beware: as a general rule, it is not a good idea to take out a second mortgage to pay off a first, because, as we said, second mortgages 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 Home Equity Line of Credit (HELOC). In the process, however, they are exposing themselves to the risk of future rate increases. HELOCs are much more exposed than standard Adjustable Rate Mortgages (ARM).
Real Estate Advice:
Generally, insurance companies are not permitted by state laws to offer or invest in second mortgages. Talk to a local real estate agent to find out if it’s the case of your state and directions of the best places to apply for a mortgage.