First mortgages are obtained out when a home is first purchased, while second mortgages are taken out some time later, when the equity in the house has grown. Therefore, the purpose of the second mortgage is not to finance the purchase of the home.

Usually, homeowners will take out a second mortgage to undertake some renovations or improvements to the property, but increasingly, people are using the equity in their homes to reduce or eliminate their high rate credit card debt.

The only time it really makes sense to take out a second mortgage for home improvement is if the project is going to add to the value of the home. There are some projects that are considered more valuable in the eyes of homebuyers, such as additional bedrooms or a remodeled ktchen, that will make them willing to pay more for the home.

Some home improvements, however, are nothing more than luxuries and will not affect the future value. An in ground pool is an example that is frequently used, since there are many buyers (with young children, for instance) who would not care to have one.

Many credit advisors recommend using a second mortgage to those homeowners who are paying high interest rates on consumer debt. Typically the interest rate on credit cards can be 16 to 20% or more, whereas a second mortgage can be obtained at 5-9%, representing a significant overall savings to the homeowner.

But be careful to use the loan for its intended purpose, and don’t “forget” to pay off those expensive consumer loans.

Since a first mortgage is paid off from the proceeds of the home in case of default, there may not be enough equity in the home to pay the second mortgage, and this is the risk the second mortgage lender takes.

Therefore, second mortgages will have a higher interest rate than first mortgages. The bank granting the second mortgage will have a higher risk that the loan will not be paid, and increased risk is one of the most important determinants of interest rates.

Second mortgages have closing costs, so you should be careful about them and make sure that they do not render the second mortgage so expensive that it will not balance out the savings you envisioned.

Since a first mortgage is for a substantial portion of the value of the home, it is for a larger amount than a second mortgage, so the closing costs are spread over a greater amount. The effect of the closing costs on a smaller second mortgage can be substantial. It is also important to shop around for a second mortgage since rates on these mortgages can be very different from bank to bank.

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