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Question:


When a person says they’ve taken a second mortgage on their home, what exactly do they mean? Is this the same as refinancing the mortgage? And is this financially sound?
-JustWonderingRandomly


Answer:


A second mortgage, like any other mortgage, is a loan in which a piece of real estate is put up as collateral and is therefore at risk of foreclosure if the borrower can’t repay the money. It’s not the same as refinancing. “Second” doesn’t mean that you had one mortgage, paid it back and took out another. Rather it refers to the pecking order among the various loans (in theory there could be a third, fourth or umpteenth mortgage) secured by the same property.
 
Say you have a house appraised at $300,000 and you owe $200,000 on your mortgage. That $100,000 in equity could allow you to borrow more against the house, so let’s say you take out a second mortgage of $50,000. Now let’s say another recession comes along the next day, the house instantly declines in value and you lose your job and can’t keep up payments. If the holder of your first mortgage forecloses and sells the house at auction for $220,000, that lender will get back the $200,000 outstanding on the first mortgage. The holder of the second mortgage, on which you owe $50,000, will get the remaining $20,000 from the sale.
 
This example shows why second mortgages are dangerous things. You have a smaller margin for error if the housing market and/or your personal finances take a turn for the worse. A second mortgage is also riskier for the bank making it, so the interest rate you pay is likely to be higher. There may be sound reasons for taking out a second – perhaps to make an improvement that you’re fairly certain will add value to the property over and above the cost of the work being done – but when it comes to mortgages, there seem to be more sound reasons to stop at one.
-Conrad de Aenlle



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