A second mortgage is a mortgage where the terms are subordinate to the first mortgage. Loans with a second mortgage are usually done when the homeowner requires money in order to pay for the existing loan.

Second Mortgage vs. Refinance

This quandary is a question every homebuyer is faced with when shopping for mortgages. Consider this scenario: A homeowner is facing a credit card debt of $50,000. Should she take a $190,000 second mortgage to refinance an existing mortgage with a balance of $140,000? Or should she appropriate the money from a $50,000 home equity loan?

In most cases, borrowers who arranged a mortgage when rates were lower will find a second mortgage better than a home equity loan. But to be satisfied, some factors need to be considered.

You should compare the interest rate and points of the first mortgage with that of a second mortgage. Second, see if there are any PMIs (Private Mortgage Insurance) involved with the second mortgage. Find out what loan term is most favorable for you with your second mortgage. Your income tax bracket and amount of upfront payment you need from your second mortgage are also necessary factors.

Consider the case previously described. If the first mortgage at $14,000 was acquired two years ago, the interest rate should be about 7 percent for 30 years without PMI. Let's say your income bracket is 39.6% (the highest) and you are capable of earning and additional five percent on your investments. Your house is now valued at $213,000.

A second mortgage for $190,000 with settlement costs would require PMI. If you opt to get a home equity loan instead, you will get 30 years loan term at 8.25% and one point. For $50,000, your second mortgage will include additional costs for 15 years at 11.5 percent and one point. The result will be that over the course of five years, your second mortgage would have saved you $11,361 more than what refinancing would.

Take a second mortgage vs. getting a new one and pay PMI

Getting a second mortgage has more benefits when it comes to taxes than a separate loan. But normally, this depends on many other factors.

Getting a second mortgage is better than getting a separate loan when the rate difference between the second mortgage and the first mortgage is minor. If the loan term is short, then getting a second mortgage reasonably makes more sense than getting a separate loan. The balance is paid off quicker with shorter term loans. Because second mortgages have considerably higher rates, the shorter the loan term is, the better it is to get a second mortgage loan.

Other factors that influence the advantage of second mortgages over separate mortgages are tax brackets, closing costs, and expected appreciation rate.

For instance, you have a tax bracket of 15 percent and a 30-year first mortgage for $160,000 and a second mortgage for $20,000 at 11.75%, zero points, and to be paid off in 15 years. A separate mortgage would be for $180,000 with down payment at 10 percent. The interest rate for this separate mortgage would be at 8.25%, zero points, and 0.52 percent PMI.

When you calculate this, you can see that over the five years, a second mortgage will have saved you 16.97 percent more than a separate mortgage would.