The difference between a first and second mortgage is simple. A first mortgage is taken out for the purchase of the home, while a second mortgage is taken out on any residual value between the outstanding mortgage balance and the value of the house.
The two most common uses that most people put a second mortgage to are home renovation and debt elimination. Both of these uses can make good economic sense if handled properly.
If you are improving your home to such an extent that it will substantially increase the value of the home, a second mortgage is probably a worthwhile investment. Certain home improvements are said to be especially helpful in increasing the value of a home, such as an additional bedroom or modernized kitchen.
Taking out a second mortgage to install an in ground pool may not be the best use for the funds, since a pool may not necessarily add to the value of a home.
Paying off high interest rate debt is probably a better way to use lower rate second mortgages, since you will save a lot of money in the long run. Typically the interest rate on credit cards can be 16 to 20% or more, whereas a second mortgage can be obtained at 5-9%, representing a substantial overall savings to the homeowner.
Make sure, however, that the cost of the new debt is balanced by the benefit received. Either the value of the home should increase to an extent that makes the loan cost worthwhile, or the savings from your credit cards should balance the cost of the loan.
Unlike a first mortgage, a second mortgage will not have priority on your home if you default. The first mortgage on your property would be repaid by your home’s value before any funds go toward the second mortgage.
For this reason, rates on second loans are higher since the bank has that risk, and the possibility of default is higher.
Just as with a first mortgage, a second mortgage will have closing costs. Make sure when you are making the decision about a second mortgage that you are well aware of all of the costs, so that you can make sure they are balanced by the increased value of your home, or the savings in consumer debt.
It really pays to shop around for a second mortgage, since the rates can vary a great deal. You should also shop around for the lowest closing costs. Closing costs for a second mortgage are a proportionately greater cost since the loan is typically for a smaller amount than a first mortgage.
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