Is Your Second Mortgage Rate Too High?
Homeowners take second mortgages, home equity loans, or home equity lines of credit on their homes for a variety of reasons.
Whether the purpose is to work on home improvements, pay off debt, or avoid paying PMI (Private Mortgage Insurance), second mortgages let you borrow against the value of your home, using your home as collateral. However, second mortgages often come in at a higher interest rate than your first mortgage.
Why is this? Well, there are a number of reasons.
Why is the interest rate on my second mortgage so high?
Your first mortgage is your primary debt, with your second mortgage being subordinate to the first. If a buyer has to default on the home, the first mortgage is first in line to be paid if the home goes into foreclosure. The second loan may get very little paid off, if anything at all, once foreclosure proceedings have finalized. To offset these risks, lenders will charge a higher interest rate.
Most lenders sell first mortgages on the secondary market—and some may sell second mortgages, as well. When a lender chooses to retain the second mortgage in-house, they charge higher interest rates to offset their costs of keeping the loan in-house.
Keeping the loan in-house may also bring additional risk. If the lender chooses the sell the second mortgage at a later time, but circumstances around the buyer’s ability to repay have changed, secondary lenders may not be interested in acquiring the loan.
Reduced interest earnings.
Second mortgages are often for a shorter term than first mortgages, resulting in lower finance charges paid over the duration of the loan. Also, there are certain types of loans which make it more difficult for the lender to calculate the amount of interest that will be paid. Interest rates on adjustable rate mortgages (ARMs), specifically, may go up or down, depending on the when the adjustment is made.
What can I do if my second mortgage rate is too high?
If you feel that you’ve signed your life away on an interest rate on your second mortgage that is too high, you may be wondering if you have any options. Let’s find out.
Evaluate your equity.
The first step you will want to take is to evaluate your financial position on your home and calculate how much equity you have. That is, if your home sold today for fair market value and you used the proceeds to pay off your mortgage, how much cash would you clear?
Sometimes equity is expressed as a dollar value, other times it is a percentage.
If the fair market value of your home is $200,000 and you owe $150,000, you have $50,000 in equity. To calculate your equity as a percentage, divide your equity by the value of your home. $50,000/$200,000= 25%.
Calculate your loan to value.
When you first bought your home, the bank calculated the amount you were allowed to borrow on your home, a ratio called loan-to-value. This is an expression of the value of your home as compared to the amount you need to borrow.
On a $200,000 home, if you needed to borrow $150,000, your loan-to-value ratio is 75% ($150,000/$200,000= 75%).
Combined loan to value takes into account a second mortgage. If you borrowed $25,000 on a second mortgage, making your total mortgage debt $175,000, your combined loan-to-value ratio is 87.5% ($175,000/$200,000=87.5%).
Banks typically limit loan-to-value ratios to 80 – 90 percent.
Know your numbers.
In order to make your next move, you will need all the details of your first and second mortgages, including interest rates, payoff amounts, prepayment penalties, and monthly principal and interest amounts.
Plan your move.
Depending on your goal, whether it is to strictly address your second mortgage payments or to achieve other financial goals, there are a few things you can do.
Refinance your primary mortgage.
If the interest rate on your first mortgage is higher than the current going rates, you can likely combine both mortgages into one loan at the present rates, which results in lower interest rates on both loans, as well as lower monthly payments.
But know that there are caveats.
If the reason for your second mortgage was for qualifying home improvements, combining both loans is probably a viable option. However, if your second loan was used for other purposes, combining both loans into your primary mortgage may be considered a “cash out refinance,” which can result in additional costs and restrictions.
Also, be aware that if you refinance your mortgage, you will start all over with paying interest on another 15- or 30-year loan. And if combining both loans puts you over an 80% loan to value threshold, you will likely have to pay mortgage insurance premiums.
Refinance your second mortgage.
If your main mortgage is at an attractive interest rate and you don’t want to mess with a good thing, you can refinance your second mortgage on its own. To decide which is the better option, to refinance your primary or your secondary loan will be a numbers game and you will need to run all the possible scenarios to determine which one will get you to your goal.
If you feel that the rate on your second mortgage is too high or have questions about refinancing, contact us at Galaxy Lending Group. We will give you all the information you need to make an informed decision that will help you achieve your financial goals.