Second Mortgages: Advantages and Disadvantages
A second mortgage is a loan taken out against the value of your property, in addition to your primary mortgage. These loans can offer great benefits, but they certainly come attached with some large risks as well.
Because second mortgages are based on the amount of equity built up in the home, they can allow homeowners to borrow a large sum of cash with the flexibility to use it for any purpose. Credit cards and personal bank loans are typically smaller and more limited in scope. Many people use second home loans for things like debt consolidation, home improvement, avoiding private mortgage insurance (PMI), paying for college tuition or investing in other properties. Other loans usually just aren’t big enough to cover these types of expenses.
Another advantage of these home loans is that they are considered safer by lenders than other types because they are secured by the house. In other words, banks will actually get something back if you default on the loan. This means borrowers will generally score much lower interest rates on second mortgages than on unsecured loans or credit cards.
And there are tax benefits of using second home loans compared with other sources. The interest from a second mortgage is tax deductible, unlike the interest from a credit card balance, for instance.
Even though banks consider second mortgages “safer,” there are still some major drawbacks involved with borrowing more money against a house. The most significant of these is that second loans are risky. If the homeowner is unable to repay the loan at some point, he risks losing his house to foreclosure and in turn ruining his credit. The risk of foreclosure does not exist with other unsecured loans. This danger of a second loan should make borrowers seriously consider whether or not they really need the large loan.
Second loans require fees and closing costs, just like first mortgages. You may also be required to pay points (one point is equal to one percent of the loan value) which could make the loan less attractive.
And while second mortgage rates are better than credit card rates, they are still higher than first mortgage loans. This is because the first mortgage takes precedence over the second in terms of repayment in the case of default.
Second mortgages can be a great way to access lower cost funding for certain major financial ventures, as long as borrowers do not overreach by taking out more money than they can comfortably afford to repay.