Second Mortgages Demystified

Many homeowners take out a second mortgage to pay off debt or to cover home improvement projects. For some, this is a good way to consolidate debt and quickly obtain funds, but is it financially advantageous for you? Prior to turning in an application, you need to be aware of several key components and fees.

Annual Percentage Rate

As with your original mortgage, the APR is the yearly interest rate on a loan or line of credit. If you have not paid off your first loan, the rates for a second may be higher because the lender will only receive payments after the first is completely paid off. The APR can increase if you incur late payments or if you take out a variable interest rate loan, which automatically adjusts payments based on new interest amounts. A variable-rate is appealing to some homeowners because initial payments are usually lower. Over time, the amount typically increases. When you are taking out a second mortgage, consider the APR carefully and don't take the first offer you get, no matter how low or attractive the rate sounds. Shop around and gather your information from at least one bank, one lender, and one credit union. Some lenders may include more than the basic interest charges, so read the fine print. Shopping around and comparing will help ensure you get the best deal possible.

Additional Fees

As with most loans, it's a good idea to find out if there are any prepayment or penalties that can catch you off guard. Many banks charge loan origination fees, which is essentially a processing fee. Origination charges are usually around one percent of the total amount. Some lenders will also charge appraisal fees. These charges can be incurred because even this process requires an appraisal on the property to determine accurate values. Flexibility is crucial, so avoid signing a contract with excessive penalties and regulations.

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Penalties and Insurance

In some cases, contracts contain a default penalty, which will increase payments if you miss a deadline. Particularly for second mortgages, default penalties can dramatically increase rates. Try to avoid contracts that include default penalties. Even if you are financially responsible, a simple clerical error could cause a payment to be late. If possible, it's best to avoid this stipulation and not even run the risk. Some lenders offer Voluntary Loan Insurance. Carefully examine this information and be sure you're not doubling up on insurance. Your agreement may already have sufficient coverage, so verify current coverage before buying a new policy.

It is crucial that you find a reputable bank or lender to help you decide whether a second mortgage is a right choice for you. Doing your homework and comparing options will also help you make the best decision. In the end, it could be financially rewarding and protect your credit and assets.