Reasons Why Second Mortgage Rates Are Higher Than First Mortgage Rates

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Why Are Second Mortgage Rates Higher Than First Mortgage Rates?

Reasons Why Second Mortgage Rates Are Higher Than First Mortgage Rates

Second mortgage interest rates are higher than first mortgage rates for the usual reason in the money lending industry: risk. The higher risk of a second mortgage loan versus a first mortgage must have a compensating factor, almost always reflected in the interest rate. Much as a personal unsecured loan has a higher rate than a new auto loan, a second mortgage has less collateral than a first mortgage and projects a much higher cost to collect monies due should the account fall into a delinquent status.

An example of the downside potential of a second mortgage from the lender's prospective might explain. You have a home valued at $250,000. You have a first mortgage of $150,000 and equity of $100,000. You borrow $35,000 through a second mortgage. Your lender earns interest on $35,000, while your first mortgage lender is earning interest on $150,000. You encounter cash flow problems and hour home is to be foreclosed upon. The second mortgage lender, already earning much less than the first mortgage lender, must now “buy out” the first mortgage, spending $150,000 (while earning nothing on this amount since you are in default), to get control of the property, manage it, insure it, and then sell it, hopefully for enough to recover their $35,000, which is now really $185,000 at risk.

This potentially expensive problem dictates that the second mortgage lender has little choice but to charge a higher interest rate on each loan to compensate for this added risk. Usually, the rate differential will not dissuade you from using a second mortgage to consolidate your higher cost debts, make home improvements, or help most other needs for cash.

   

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