A 125% second mortgage is a loan that, when added to the amount you owe on your original mortgage, amounts to 125% of the home’s current appraised value. It is the ultimate “cash out” home equity loan – except for the fact that much of the loan has no equity securing it at all. The 125 second mortgage is an option that generally falls to people who are strapped for cash and are willing to risk their home to get out of the jam.
A home equity loan – another term for a second mortgage – is a loan that allows the homeowner who has accumulated equity in his/her house to convert that equity to cash by borrowing against it. The 125% second mortgage takes the notion beyond equity, and creates a loan that puts the homeowner in a position of owing more on the house than it is worth. While the cash may be an absolute necessity, the consequences of a loan like this can be severe.
Because these loans are not really secured by equity, the interest rates on them can run as much as six percent higher than standard second mortgages. Furthermore, much of that interest is not going to be tax deductible. The IRS allows for tax deductions on home loan interest for loans of up to 100% of the home’s value. The interest on that extra 25% is not deductible. A 125% second mortgage provides cash at a high premium and without the deduction benefits of a true mortgage.
The presence of a second mortgage on your property may hinder your ability to refinance the first mortgage, should interest rates improve and provide a financial opportunity. The holder of the second mortgage must provide permission in order for the homeowner to refinance the first. Some will be agreeable, others will charge a fee, and still others will decline.
The other major negative impact of a loan that has a unsecured portion is that should you need to sell the home because of job relocation or some other reason, you will have to come up with the cash balance owed the lenders after the home has been sold. If you owe 25% more than it is worth, you will need a substantial bundle of cash in order to get out from under the home.
These loans were created in the heyday of rising home prices. Today, they carry additional risk because home prices and sales have leveled off. It is never a good situation to owe more than your home is worth – it constricts your personal options and the money you have borrowed is both expensive because of high interest rates and because there is no deduction for those interest payments.