Having a second mortgage is bad, right?
Ron February 6th, 2007
I hear this question from 75% of my customers whenever I suggest a second mortgage. This stereotype is often communicated because of phrases like, I had to take out a second mortgage on my house in order to pay for this!
But contrary to popular belief, a second mortgage is a creative mortgage planning tool that is usually reserved for only the most credit-worthy customers. As such, a second mortgage is often the most cost-effective method to finance a down payment, to avoid costly private mortgage insurance, or to make other large purchases.
By dividing up a mortgage loan into two components, like a first mortgage and a second mortgage, I show my clients how to minimize the amount of interest and private mortgage insurance that they pay. To demonstrate with a specific example:
Jacob and Sarah want to finance their new $200,000 home, and they have set aside $10,000 for a down payment on their new home. They will need a $190,000 mortgage loan, and they want to finance this $190,000 mortgage loan using very conservative mortgage financing options.
So together, we discover that they will want a 30 year fixed rate mortgage: This will minimize their monthly payments and will protect them from any future increase in interest rates. (With a 30 year fixed rate mortgage, their payments are set for 30 years, and their rate will not change because of future increases in interest rates.) They will also have the option of paying additional principal on the mortgage whenever they choose to. I also run an amortization schedule for them, showing them how they have the ability to pay off their 30 year mortgage in 22 years just by making 1 extra payment/per year!
So here are the specific options I present to them, all assuming 30 year fixed rate/fixed payments.
Option #1:
Borrow $190,000 on one mortgage loan with private mortgage insurance.
First mortgage principal and interest: $1154. (assumes rate of 6.125%.)
Private mortgage insurance payment: $112.
Total mortgage payment: $1266 plus applicable taxes/insurance.
Option #2:
Borrow $190,000 on one mortgage loan without private mortgage insurance (with higher interest rate.)
First mortgage principal and interest: $1215. (assumes interest rate of 6.615%.)
No private mortgage insurance required.
Total mortgage payment: $1215 plus applicable taxes/insurance (savings of $51/month.)
Option #3:
Borrow $190,000, divided between a first mortgage for $160,000 and a second mortgage for $30,000.
First mortgage principal and interest: $972 (assumes rate of 6.125%.)
Second mortgage principal and interest: $217 (assumes rate of 7.85%.)
No private mortgage insurance.
Total mortgage payment: $1189 plus applicable taxes/insurance (savings of over $77/month.)
As you noticed, the rate on the second mortgage is higher than the rate on the first mortgage, but the OVERALL cost is lower. And the mortgage interest is usually tax deductible, unlike private mortgage insurance.
In addition to teaching Jacob and Sarah how to save $77/month ($924/year), I also teach them how this option will allow them to more effectively manage their mortgage financing post-closing.
Unlike option 2 (one mortgage with no private mortgage insurance with the higher interest rate), option 3 gives Jacob and Sarah the flexibility of paying off the higher rate second mortgage FIRST, which will eventually leave them with only one mortgage at the lower interest rate.
So after paying off their higher rate second mortgage, my customers will eventually left with only one mortgage with a payment of $972/month. (Note that the payment is significantly less than option 2 which requires a mortgage payment of $1215/month for the full 30 years.)
There are additional benefits for other customers in different situations as well: I can help my customers take out a second mortgage or home equity line of credit that will allow them to access the equity in their home without restructuring or refinancing their low rate first mortgage. Also, mortgage rates on second mortgages (roughly 6.95%-8.75%) will often offer lower interest rates and lower payments than high interest rate credit cards. Borrowing $5,000 on a home equity line of credit at 7.75% carries an interest only payment of $32/month and is usually tax deductible versus borrowing $5,000 on a 14% credit card with a required monthly payment of $125 month that is not tax deductible.
If you have any further questions on this article, please feel free to contact me via email at ron.erdmannjr@ncmc.com or directly at (513) 470-3481. I have the ability to lend mortgage loans and lines of credit to qualified customers in almost any city or state.
