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What is Second Mortgage ?
Before knowing what second mortgage
is, it is important to know what is meant by mortgage. Mortgage
is a method of using a property as security for the payment of a
debt. It is mostly associated with loans secured on real estate
or sometimes only lands than any other property such as ships
etc. This is most widely used methods by anyone especially
business men in purchasing any real estates or residents wherein
they do not have to pay the full amount in one stretch or
immediately. Coming to second mortgage, it is like as subsidiary
to any other loan taken against the same property. It is like a
second loan in series. It can be explained better in this way: a
loan that is registered with the province first is called the
first mortgage and the one that is registered second is called
the second mortgage. Similarly there are third and fourth
mortgages that are rarer. Usually a real estate can have more
than one loan against it. The maximum amount of the second
mortgage is calculated by the equity in the home. Equity is
nothing but the difference between what is owned on the home and
the value of the home. It is arranged or taken for various
purposes such as for college fees, financing home improvements,
emergency cases, debt consolidation etc. It usually carries a
higher interest rate compared to the first mortgage. In the long
run they are found to be less expensive compared to refinancing
since they have less transaction costs despite of higher
interests.
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Second mortgage can be explained
with an example in the following way
Suppose a person takes mortgage of two lakh rupees on his home a
couple of years ago and has to still pay back around fifty
thousand rupees. If he takes another mortgage on his home equity
i.e. one lakh fifty thousand rupees (difference amount of two
lakh and fifty thousand rupees). That is nothing but the second
mortgage on the same property.
Types
There are two types of second mortgages which include
Home Equity line of credit.
Fixed Rate Mortgages.
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Home Equity
line of Credit: These are second mortgages which are
an Adjustable Rate Mortgage (ARM). The interest will be fixed
for a particular period of time in this loan and then will be
adjustable for the remaining loan amount. The adjustment is
based on the changes on the previously defined period, generally
once a year and previously selected index. The common indices
include London Inter-Bank Offered Rate (LIBOR), Treasury Bill,
Cost of Funds Index (COFI) and Certificate of Deposit (CD). The
payment that has to be made monthly and the interest rate
depends based on the changes made in the index. A line of credit
is operated similar to a credit card where in there is a maximum
limit to withdraw the amount of money.
The entire amount can be paid before the period, but the line
must be kept opened for further withdrawing any amount needed.
But the line of credit has a fixed length of time to withdraw
and clear the debt unlike the credit card. When the term of the
loan is over the entire amount must be paid back.
Fixed Rate Mortgages: These
mortgages have fixed life for a loan and fixed interest usually
the length of the mortgage is about 15-30 years.
Features
The Main Features of second mortgages are explained in brief
below
As there are risks involved in giving second mortgages, the
interest rate charged is higher compared to first mortgages. The
rate of interest charged depends completely on equity of the
home and the credit score.
These mortgages are given as home equity loan or home equity
line of credit. In home equity line of credit, an individual can
withdraw cash advances up to a maximum credit limit within the
given loan period and in home equity loan the amount is given in
one stretch as a whole.
Home equity loans have fixed interest rates and periods but
home equity line of credit have adjustable rates wherein the
interest rates are fixed for an initial term, and after a period
they vary periodically.
Generally second mortgages have loan period varying from 15 to
30 years. In home equity line of credit the cash advances can be
withdrawn within first ten to fifteen years and then repay the
loan so that the second mortgage is paid off within the
remaining loan period.
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Benefits
The benefits of second mortgage are given as follows
It helps in combining all the unsecured debts that are of high
interest rates and mortgage loan so that the total monthly
payment that has to be paid on the debts is reduced.
It is free of tax up to certain extent because the interest on
second mortgage is tax deductible.
A second mortgage that is worth about ten percent of the asset
value and first mortgage for eighty percent of the same value
and an initial or down payment of ten percent would help in
avoiding paying for the private mortgage insurance.
The amounts for second mortgage home loans are less compared
to that of first mortgages and hence their chances of approval
are more.
One more advantage of second mortgage is that these loans help
in converting the home equity into cash that can be used for
educational purposes, home improvements etc.
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Other
Factors to be considered
There are certain other factors that need to be considered in
choosing a second mortgage or there are certain things that a person
need to know regarding second mortgage that includes:
Second mortgage rates.
Payment calculations.
Costs.
Length.
Second Mortgage Rates: Many
companies give adjustable rate mortgages (ARMs) where in the rate of
interest for this is periodically adjusted. It is important know
when the mortgage company will change the interest rate, how often
it would change, any limits for the change and on what basis the
change is made.
Payment calculations: It is
important to know from the mortgage company as to how much will be
the monthly payment every month. This is because monthly payments
are made on the principal amount and the interest for some loans and
for the others it is made only on the borrowed amount. In this case
the monthly payments will not reduce the principal amount of the
loan and the entire borrowed amount has to be paid back at the end
of the loan period. Such loans are known as balloon loans.
Costs of second mortgage: Most
of the mortgage companies charge for giving loans. These charges are
usually a percentage of the loan. They are known as points. It is
safe to get the amount of fee to be paid in writing from the
mortgage company before taking the loan.
Length of second mortgage: The
length of the second mortgage means that the term given to repay the
loan. This varies from one company to the other and the term may
vary from one year to fifteen-twenty years. It is important to
discuss regarding this with the mortgage company before taking the
loan so that it will be suitable for you.
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Article Contributed By: Jaya Suresh
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