Professor's House

Should you get a Second Mortgage

The words “second mortgage” actually sends chills down our spine, but then we’ve always been fiscally conservative. And boring. And not one to take risks. That’s why someone teased us one day that we would be forever poor. Perhaps it’s about time we take a few risks in life so we can fatten our wallets for a change.

Different strokes for different folks!

The only reason we shudder at the words “second mortgage” is ignorance. If we’ve never dabbled in a second mortgage, we’d have to be 100% convinced that it’s not as bad as it sounds. Up until four years ago, we thought of a mortgage as anathema – something to be avoided like the bubonic plague. So a second mortgage sounds even more like a double dose of the plague.

Not if you speak to financial experts and request to be enlightened.

Actually, second mortgages are common currency these days and there is nothing to be frightened about, provided you manage your debts and portfolio intelligently. If you are thinking of a second mortgage, speak to your financial adviser or accountant who can give you sound advice.

What’s a Second Mortgage?

Before we explain what a second mortgage is, let’s first say WHY people apply for a second mortgage.

The first – and probably the only reason – is a need for cash. Cash will always be king. Next to love, it makes the world go round, and it enables us to fund our dreams and secret longings. There are many channels by which access to cash is made possible, but some people prefer to do it via a second mortgage. Usually, it’s because the terms and conditions may be better since there is collateral (your house or your rental building). It could also be also that the interest rate is lower since it’s tied to equity.

To use a minimalist definition, therefore, a second mortgage is a loan we take out on our house. The first, original mortgage still exists, and if we’ve got a small balance left on the first mortgage, lenders will usually allow us to take a second mortgage.

Just as an aside, we once read that there’s a hotel in Florida – we forget the name now – that had 13 mortgages on it! It makes you wonder what the owners were thinking by taking 13 mortgages on one piece of property. In the world of real estate investing, savvy investors probably don’t bat an eyelash when they hear of properties having multiple mortgages. That’s their way of doing business, and for some apparently, it can be very profitable. But that’s an altogether different subject matter.

Within financial circles, a second mortgage is a loan that has been used as a collateral for an earlier mortgage; note that the rights of a second mortgage take second priority to the rights of the first mortgage. To illustrate: you have a house worth $200,000.00. You’ve managed to pay off 50% of the mortgage so that leaves you with $100,000.00. You see another house in your neighborhood that you’d like to purchase so you can convert it to a bed and breakfast. You can only make a 5% downpayment on this second property. How do you finance the 95% balance for it? A second mortgage is one avenue.

If your first mortgage is with institution A, and your second mortgage is with institution B, just bear in mind that should you default or declare bankruptcy, institution A gets priority for receiving payment when all your assets are liquidated. Only AFTER institution A has been paid that institution B receives payment (that is, if there’s anything left).

Second Mortgage: Cash for Different Reasons

We said earlier that cash is the underlying reason why people seek a second mortgage. What kinds of things do people need cash for?

One, to renovate or to add a structure to a house. For example, the mother-in-law will no longer be able to live by herself so she comes to live with you. You’ll need a bedroom for her, or a separate studio that you can build in your backyard.

Two, to finance the education of your children. If your daughter wants to go to law school in Harvard or Princeton, you could be looking at a minimum of $60,000 a year, and that’s not counting board and lodging, textbooks, and service fees. (You either take a second mortgage or ask her to get her education in Canada where tuition fees are much more reasonable and the quality of instruction is just as good!).

Three, to consolidate debt. Debt consolidation is a solution for people who have an array of credit card debt, department store debt, business start-up debts, and other kinds of debts. Instead of making several payments on these debts, people take out a loan to pay them off, so they’re just left with one loan to pay. It’s usually very difficult to keep track of the various interest rates on a slew of loans, and by taking on a second mortgage, there’s one interest rate and one monthly payment.

If you have good credit, lenders are willing to offer you a lower interest rate on your second mortgage. You pay a fixed amount weekly or monthly with a pre-established schedule for repayments. Lenders can also offer lines of credit on a second mortgage to help you with your cash requirements.

Second Mortgage: Be Cautious!

If you’ve wondered about the term of second mortgages, they can have an amortization period of 15 to 25 years, while others may have much shorter amortizations of 12 months. Crunch the numbers carefully and find out which term is appropriate in your case so that you don’t get trapped into a negative cash flow position.

Another thing you should do is carry out basic due diligence. This means that you should read the second mortgage contract and question your lender about any words or phrases you do not understand. Better yet, have your lawyer read the loan document so he can clue you into potential pitfalls.

In order for your lender to properly structure a loan that’s in line with your budget, be honest with him 100%. Don’t say you want to renovate a basement when you’re actually eyeing a stock that you heard will be soaring in price in the next three months. We’d like to stress this point because if your lender finds out you used the money for a purpose other than what you stated on the application form, he may put you on his watch list.

One vital lesson we learned in life: there are two persons in life you never lie to: your doctor and your banker. We may tell the occasional white lie to mom and pop, or to our spouse, but don’t fool around with your banker and doctor. The first one provides you wealth, the second one health. Pay heed.

A Better Alternative to a Second Mortgage

Like we said earlier, the sound of a second mortgage would make us shudder, but only because we’ve never done it. Circumstances being equal and barring any special requirements, we would recommend taking out a line of credit on your home rather than a second mortgage. If you’ve been a disciplined borrower, we don’t see why your banker would not increase the amount of your line of credit to satisfy your need for cash. Our educated guess is that it is easier to negotiate a line of credit than a second mortgage. A second mortgage has a term that we have to abide by, a line of credit does not. In fact, a line of credit will always be available and need not be paid after X number of months.

Another alternative of course is to refinance your first mortgage. You could increase the amount of the loan based on how much equity you’ve built in.

But our most sublime advice: when in doubt, always seek legal counsel.

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