What is Second Mortgage Interest?
Second mortgage interest is the interest that accrues on money you have borrowed from a lender, using your home or other property as collateral. The lender charges this interest in return for providing you the loan amount so you could purchase the property, reorganize debts or other reasons.
You can expect to pay a higher interest rate on your second mortgage than you pay on your first mortgage. This type of loan is subordinate to the first mortgage, which means the lender has more exposure to potential loss. If you were to default on the second mortgage, the lender could not foreclose unless the first were paid off. Their only recourse would be to buy the first mortgage, if for sale, and then they could foreclose.
If you are exploring the possibility of obtaining a second mortgage on your residence, you need to do some research. There are important decisions:
- Should you consider an ARM (Adjustable Rate Mortgage)?
- Will this be a home equity loan, or strictly for home improvement?
You need to be sure before you incur this debt that there is not going to be any payment shock down the road, and that the interest will be tax deductible.
Although an ARM loan may offer a lower interest rate than a conventional loan for an initial period of time, you run the risk of interest rates going up. The amount of interest is tied to an Index of loan interest rates such as the Cost of Funds Index (COFI). The lender will add a few percentage points (their margin) to this figure to arrive at your interest rate. If the average interest rates go up, so will your interest and either your payment goes up, or the extra interest will increase the amount of your loan. You need at a minimum to understand these terms for a potential ARM loan:
- Is there a cap on how high the interest can be raised?
- How often can it be raised?
- Will your interest go down if the Index goes down, or always stay at the highest level?
- What is the source for the Index, and what is the margin the lender is adding?
- When are payments adjusted?
- Are there points being charged?
- What are the closing costs?
A good interest rate may obscure the fact that the total amount of the loan is being inflated by fees the lender charges (loan origination fees) and points they charge. For example, if the lender charges 2 points, they would add $2,000.00 to a $100,000 loan. If they charged 4 points, that would add $4,000.00 to the loan. Lenders will inflate the points to offset charging a lower interest rate, and charge all of the costs of originating the loan to you.
If you have an ARM “interest only” loan, your payments may be low for the period of time agreed upon (often 3 to 10 years), but then will go up when you have to start paying interest and principal.
A fixed rate mortgage will allow you to have stable payments so you can plan your finances. However, you are locked into that rate and if interest rates go down in the future, you would have to go through refinancing to take advantage of them. These loans can be for 15 to 30 years, although sometimes they are given shorter maturity dates. Although you can find fixed rate mortgages that will offer a lower initial rate, and then raise the rate later, they are less common. When considering a fixed rate loan, you also need to consider points and fees that the lender may be planning on adding to your loan.
You especially need to understand the terms of your second mortgage and the type of loan for tax deduction purposes. The IRS makes a distinction between loans taken out to buy, build or improve your home, and those taken out for other purposes such as debt consolidation, called home equity loans. Depending on the date you took out the loan, there is a limit on the total amount of debt you can have on your home, and the interest still be tax deductible. These are the basic requirements for the interest on your second mortgage to be tax deductible:
- The loan must be on your own residence, either a primary or second (e.g. vacation) home. The second home cannot be an investment that you rent out-you have to live in it at least part of the year or the interest is an investment or rental income deduction
- The home is the security for the loan, and could be sold to satisfy the loan
- The trust deed (instrument of debt) is recorded at the appropriate government agency
- Your mortgages were all taken out before 10/13/1987 or;
- If taken out after that date, loan was used to buy, build, or improve the home secured by that main home mortgage , did not exceed one million dollars or one half million if married filing separately; and
- The equity loan does not exceed $100,000 (or $50,000 married filing separately) at all times during the year
Before you use the second mortgage interest as a tax deduction, you need to review IRS Publication 936 “Home Mortgage Interest Deduction“, which contains all the information needed to determine if interest on a mortgage is deductible.
If you have equity in your home and wish to access it using a second mortgage, you should be sure to shop around for the best rate from different sources. Start with the financial institution that holds your first mortgage. But don’t assume their rates and terms are automatically going to be the best. A little time spent shopping could save you considerable money and grief later on; and remember that the interest rate is not the whole story on the loan: terms and costs can be just as important a factor in your decision.
Second mortgage interest refers to either the interest rate or the amount of interest paid on money borrowed in the form of a second mortgage. In a second mortgage, a borrower takes all or a portion of the equity from his home in the form of a loan. This is often done for the purpose of paying off high-interest debt such as credit card debt, or for making improvements to a home. The interest rate on a second mortgage is almost always significantly higher than that of a first mortgage. Some of the parameters of second mortgages are similar to those of first mortgages. For instance, second mortgage interest rates, if they are fixed, will remain constant throughout the term of the loan. If the second mortgage interest rate is adjustable, the rate will change at regular intervals. The differences can make a huge impact on the borrower, however. The amount of time the borrower has to repay the loan is usually shorter than in the case of first mortgages. This is because a second loan represe
