Why Do Second Mortgages Have High Interest Rates?
The mortgage rates on a second mortgage are usually higher than on the first one. There are several reasons for this which people need to understand before opting for a second mortgage. A few key reasons for the higher interest rates on second mortgages are mentioned below.
This is the most basic reason because of which second mortgage rates are higher. A second mortgage rate is secondary to the first loan. When a borrower defaults on their mortgage payments and the home is filed for foreclosure, the priority is given to the first mortgage loan. The lender of the second loan receives a certain amount of the loan or none at all depending on the money that was recovered during the foreclosure. To offset such a risk, most lenders charge a high interest rate on the second mortgage.
Low Interest Earnings
Second mortgages usually have a shorter term than first mortgages. This does not give the lender enough time to earn a sufficient amount of interest from the loan. The costs of borrowing as well as the finance charges due on the borrower are quite less. This is why many second mortgage lenders charge high interest rates in order to earn maximum profits on their lending amount.
Inability to Calculate Accurately
In case of an adjustable rate mortgages (ARM), the lender may not be able to calculate accurately the total interest amount they will be able to earn. This is because the mortgage rates can fluctuate at every adjustment point. Due to the amount of uncertainty in these types of mortgage rates, most lenders secure their earnings by charging higher interest rates on their second adjustable rate mortgages.
Mortgage Used for Repairs
Sometimes, borrowers may request for a second mortgage to make some repairs in their home. A mortgage loan that is requested to make repairs may be a signal that there is a possibility of more problems arising in the future. This is considered as an alarm and lenders try to offset any potential future risks by charging higher mortgage rates.
In case the borrower opts for a balloon mortgage or interest only mortgage as a second mortgage, the lender has to consider all possibilities of receiving payments. The financial situation of the borrower, during the term of the loan, may decline due to any reason. If in this case, the borrower is unable to pay back the lender, the lender may end up losing the entire loan amount. To secure themselves, lenders charge a higher interest rate on such mortgages if they are being offered as a second mortgage.
A second mortgage is usually an extra financial burden on the borrower. More often than not, if the borrower is servicing his first loan with the second, there is a lower possibility that he/she will be able to repay the second mortgage repayments on time. This is a warning for lenders who try to safeguard their side by charging higher second mortgage rates from borrowers.