Second Mortgages

If you are like most homeowners, you probably have a first mortgage loan on your home. As you make monthly mortgage payments and the value of the home increases, your interest in the property (called "equity") grows. After a while, some homeowners may wish to borrow against the equity in their home to get cash, to make home improvements, to educate their children, or to consolidate personal debts. Because such loans are in addition to the first mortgage on the home, they are commonly called second mortgage loans.

Second mortgage loans are different from first mortgages in several ways. They often carry a higher interest rate, and they usually are for a shorter time, 15 years or less. In addition, they may require a large single payment at the end of the term, commonly known as a balloon payment.

Traditionally, second mortgage loans are offered with a fixed loan amount and a predetermined repayment schedule. Some lenders now offer lines of credit that allow you to obtain cash advances with a credit card or to write checks up to a certain credit limit. These often are called "home equity lines" because the equity in your home is collateral for the amount of credit you request. As you pay off the outstanding balance, you can reuse the line of credit during the loan period.

Second Mortgage Repayment

Some second mortgage loans may extend for as long as 15 or 20 years; others may require repayment in one year. You will need to discuss the repayment terms with the lenders and select one who offers terms that best suit your needs. For example, if you need to borrow $20,000 to make repairs on your home, you may not want a loan that requires you to repay the entire amount in one or two years because the monthly payments may be too high.

Second Mortgage Costs

Many companies will charge a fee for lending you money. The fee is usually a percentage of the loan and is sometimes referred to as "points." One point is equal to one percent of the amount you borrow. For example, if you were to borrow $10,000 with a fee of eight points, you would pay $800 in "points." The number of points lenders charge varies, so it may be worthwhile to shop around. If the fee seems too high, you may be able to bargain for or find a lower fee. Be sure to get the amount of the fee in writing before you take the loan. Many states limit the amount of fees a lender may charge on a second mortgage loan. You may want to check with your state's consumer protection office or banking commissioner to determine whether there is a limit in your state.

Second Mortgage Repayment and Length

Be sure you understand how much your monthly payments will be and what they cover. Your lender should be able to give you this information in advance. With some loans, you will be required to make monthly payments on the principal and interest. With other loans, you may be required to pay interest only on the borrowed amount; in these loans, your monthly payments will not reduce the principal amount of the loan. With such a loan, you will be required to pay back the entire borrowed amount at the end of the loan period. These loans are popularly known as "balloon loans." If your loan has a balloon payment, you should consider how you will arrange to repay the entire amount when it becomes due.

On "home equity lines," the lender does not have to give you the exact amount of the monthly payment, but must explain how it is figured. This is because the borrowed amount will vary and your outstanding balance will change if you use the line of credit. However, if your monthly payment term is 5% of the outstanding balance and your outstanding balance is $5,000, your minimum monthly payments would be $250.

Second Mortgage Rates

If you have a fixed-rate loan, the interest rate is set for the life of the loan. However, many lenders offer variable rate mortgages, also known as adjustable rate mortgages or ARMs. These provide for periodic interest-rate adjustments. If your loan contract allows the lender to adjust or change the interest rate, be sure you understand when the lender has the right to change the interest rate, whether there are any limits on how much the interest or payments can change, and how often the lender can change the rate. You also should know what basis the lender will use to determine a new rate of interest.

Home Equity Credit Line

If you need to borrow money, home equity lines may be one useful source of credit. Initially at least, they may provide you with large amounts of cash at relatively low interest rates. And they may provide you with certain tax advantages unavailable with other kinds of loans. (Check with your tax adviser for details.)

At the same time, home equity lines of credit require you to use your home as collateral for the loan. This may put your home at risk if you are late or cannot make your monthly payments. Those loans with a large final (balloon) payment may lead you to borrow more money to pay off this debt, or they may put your home in jeopardy if you cannot qualify for refinancing. And, if you sell your home, most plans require you to pay off your credit line at that time. In addition, because home equity loans give you relatively easy access to cash, you might find you borrow money more freely.

Remember too, there are other ways to borrow money from a lending institution. For example, you may want to explore second mortgage installment loans. Although these plans also place an additional mortgage on your home, second mortgage money usually is loaned in a lump sum, rather than in a series of advances made available by writing checks on an account. Also, second mortgages usually have fixed interest rates and fixed payment amounts.

You also may want to explore borrowing from credit lines that do not use your home as collateral. These are available with your credit cards or with unsecured credit lines that let you write checks as you need the money. In addition, you may want to ask about loans for specific items, such as cars or tuition.