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How to Understand Second Mortgages
There are two types of standard home loans on a home: a first mortgage and a second mortgage. The first mortgage is the original mortgage that is obtained to build or buy the home. The second mortgage is taken out some time later, for a different purpose.
Usually, homeowners will take out a second mortgage to undertake some renovations or improvements to the property, but increasingly, people are using the equity in their homes to reduce or eliminate their high rate credit card debt.
If you are improving your home to such an extent that it will substantially increase the value of the property, a second mortgage is probably a worthwhile decision. Certain home improvements are said to be especially helpful in increasing the value of a home, such as an additional bedroom or an upgraded kitchen.
Some home improvements, however, are really just luxuries and will not affect the future value. An in ground pool is an example that is frequently mentioned, since there are many buyers (with young children, for instance) who would not care to have one.
Paying off high interest rate debt is probably a better use of lower rate second mortgages, since you will save a lot of money in the long run. Replacing 16 to 20% debt on your credit cards with 5-9% debt on a second mortgage really does make a lot of sense.
But be careful to use the loan for its intended reason, and don't "forget" to pay off those expensive credit card loans.
Second mortgages are exactly that in actuality as well as in name, because they are paid off after the first home loan is paid, and the bank has to hope there is equity to cover it.
For this reason, rates on second loans are higher because 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.
Since a first mortgage is for a substantial portion of the value of the home, it is for a larger amount than a second mortgage, so the closing costs are spread over a greater amount. The effect of the closing costs on a smaller second mortgage can be significant. It is also important to shop around for a second mortgage since rates on these mortgages can be very different from bank to bank.
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