A simple definition of a second mortgage – it is a mortgage behind the first mortgage. While the definition is simple, however, it becomes complicated when a mortgagor (borrower) defaults his/her payments that would lead to a power of sale – that is the mortgaged property is sold by court order to pay off the existing mortgage(s).
Banks, as primary lenders would give first mortgages to borrowers up to 80% of the value of the property. Any mortgage more than 80% of value of the property is called a “high-ratio mortgage” where an insurance is required to protect banks in the event the proceed of sale (when the mortgage property is sold) is lower than the outstanding balance of the mortgage.
Banks do not give second mortgages when the amount of advance is more than 80% of value of the property.
It is only secondary lenders like: finance companies and private individuals give second mortgages more than 80% of value of the property without insurance requirement as in banks.
Finance companies would give up to 90% of the value of the property, while private individuals could give up to 95% of value of the property.
Interest on second mortgages are higher than first mortgages, for lenders of second mortgages assume the risk of losing their investment when the value of property mortgaged is sold through power of sale, where the proceeds of sale is not enough to pay both the first and the second mortgages.
The order of payment when the mortgaged property is sold through power of sale is to pay the first mortgage, then the second mortgage, if there is still amount left from the proceeds of sale. Otherwise, the second mortgage lender may get only a portion of his/her investment or lose all of it.
It is tempting to invest in a second mortgage for you can earn an interest rate from between 12% to 16% per annum. In addition, you will also receive from the borrower a lump-sum amount of “lender’s fee” from $500.00 to $2,000.00 depending on the amount you invest and the risk involve.
To minimize the risk above mentioned, require a borrower or a broker who arranges the deal to submit a current appraisal of the property by a licensed appraiser, proof of income of the borrower(s), latest statement of the first mortgage, latest statement of the property tax from a city or town where the property is located, and a latest credit report of the borrower(s) from the credit bureau.
With the above information, you have the basis of evaluating the risk you will assume should you invest in a second mortgage. If in your evaluation, it is too risky, do not invest.
Moreover, do not place all your eggs in one basket – that is do not invest all your money in one property to avoid losing all of it should a borrower defaults his/payments and the property is sold through power of sale, and the proceeds of sale is not enough to pay your second mortgage investment. You need to be cautious to protect hour hard –earned money.