Second Mortgage
A second mortgage is a mortgage whose terms are subordinate to the
first mortgage. Loans with a second mortgage are usually done when
the homeowner needs money in order to pay for an existing loan.
Second Mortgage or Refinance?
This is a question every homebuyer is faced with when shopping for
mortgages. Take this scenario: A homeowner is facing a credit card
debt of $50,000. Should he take a $190,000 second mortgage to refinance
an existing mortgage with a balance of $140,000? Or should he borrow
the money from a $50,000 home equity loan?
In most cases, borrowers who took a mortgage when rates were lower
will find a second mortgage better than a home equity loan. But to
be certain, some factors need to be considered.
You need to compare the interest rate and points of the first mortgage
with that of a second mortgage. Second, find out if there are any
PMIs (Private Mortgage Insurance) involved with the second mortgage.
Find out what loan term is most favorable for you on your second mortgage.
Your income tax bracket and amount of cash you need from your second
mortgage are also necessary factors.
Consider the case above. If the first mortgage at $14,000 was acquired
two years ago, the interest rate would be 7 percent for 30 years without
PMI. Let’s say your income bracket is 39.6% (the highest) and you
are capable of earning 5% more on your investments. Your house is
now worth $213,000.
A second mortgage for $190,000 with settlement costs will require
PMI. If you decide to get a home equity loan instead, you will get
30 years loan term at 8.25% and one point. For $50,000, your second
mortgage will include additional costs for 15 years at 11.5% and one
point. The result will be that over the course of five years, your
second mortgage will have saved you $11,361 more than what refinancing
will.
Take a second mortgage or get a new one and pay PMI?
Getting a second mortgage has more advantages when it comes to taxes
than a separate loan. But usually, this depends on many other factors.
Getting a second mortgage is better than getting a separate loan when
the rate difference between the second mortgage and the first mortgage
is small. If the loan term is short, then getting a second mortgage
probably makes more sense than getting a separate loan. Balance is
paid off faster with shorter term loans. Since second mortgages have
considerably higher rates, the shorter the loan term is, the better
it is to get a second mortgage loan.
Other factors that affect the advantage of second mortgages over separate
mortgages are tax brackets, closing costs, and expected appreciation
rate.
For example, you have a tax bracket of 15% and a 30-year first mortgage
for $160,000 and a second mortgage for $20,000 at 11.75%, zero points,
and to be paid off in 15 years. A separate mortgage would be for $180,000
with down payment at 10%. Interest rate for this separate mortgage
would be at 8.25%, zero points, and 0.52% PMI.
When you calculate this, you can see that over the five years, a second
mortgage will have saved you 16.97% more than a separate mortgage
would.
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