Second Mortgage Definition
In case you're not familiar with the term, a second mortgage (otherwise referred to as a Home Equity Loan) is simply a loan taken out against your home after you already have a first mortgage.
What is Second Mortgage?
Basically, a second mortgage allows the borrower to tap into the equity they have accumulated over the course of repaying their first mortgage. Equity is the difference between what you owe on the home and what the home is expected to sell for. So if you currently owe $125,000 on a home that would sell for $150,000, you would have $25,000 in equity.
Of course, the lending institutions view the equity in your home as a potential revenue source. Depending on how much of your home's appraised value they are willing to allow you to borrow (loan to value ratio), lending institutions are usually quite anxious to let you re-borrow a portion of the funds you've worked so hard to pay off.
Most people who take out second mortgages do so because they need access to a large sum of cash, cash for things like home remodeling, debt consolidation, or paying for their child's college education.
Disadvantages of Second Mortgages
The drawbacks to taking out a home equity loan, are as follows.
Increased Risk: If an unexpected event causes your income to drop and you can no longer afford your first mortgage payment, you may end up losing your home -- but still be liable for the 2nd loan. That's because the holder of the first house loan gets paid first when the home is sold in foreclosure, and if the proceeds aren't enough to cover the equity loan, you are left holding the bill -- even though you no longer own the home.
Higher Rates: Since the lender holding the equity loan is more at risk than the primary lender, interest rates for second mortgages are typically higher than rates for first mortgages. Therefore, if you are considering an equity loan, you might be better off refinancing your first mortgage with a "cash-out" option. This would allow you to withdraw the needed cash from your available equity while still paying the lower interest rates.
Living Beyond Your Means: Make no mistake, if you are borrowing money to purchase goods and services, you are living beyond your means. And the more you live beyond your means, the more likely it is that at some time in the future your over-spending will catch up with you -- perhaps causing you to endure a long period of financial hardship.