Second mortgages are loans, which provide an opportunity to borrow money against the value of your home. In many cases, when you buy a property, its value increases over time. A second mortgage enables you to benefit from the equity in your home. If you take out a second mortgage, you can use the money for a range of projects and access capital without selling your home. If you’re trying to raise funds or considering borrowing money, this guide will tell you everything you need to know about second mortgages.
What Exactly Is a Second Mortgage?
Second mortgages are a loan that you take out against your property. In essence, this type of financial product enables you to capitalize on the equity in your home. If you take out a second mortgage, your home will become collateral. The second mortgage is so-called because if you fall behind with mortgage payments, the first mortgage will be paid off first in a foreclosure. Once the first mortgage is paid off, any remaining funds will go towards the second mortgage. Second mortgages differ from other types of loans, such as auto and student loans, because they can be spent on almost anything. Do you need help getting a second mortgage? Mares Mortgage is here for you.
Understanding Home Equity
To discover how a second mortgage works and how it can be beneficial, it’s crucial to understand home equity. The amount of equity in your property will affect your borrowing. The more equity you have, the higher the loan value. To calculate the equity tied up in your home, you subtract the amount of money you have paid so far from the total sum you borrowed to buy your house. The equity relates to the portion of your home that you have paid off and own outright. If you borrowed $200,000 to buy your home, for example, and you’ve paid off $75,000, you will have $75,000 in equity. Interest fees you have paid do not get included in your equity calculation. Changes in value, for example, undertaking home improvements, can also affect equity.
What Is the Difference Between a Second Mortgage and Refinancing?
If you’ve looked into taking out a second mortgage, you might have stumbled across the term ‘refinancing’ before. Refinancing is different from a second mortgage. Mortgage refinancing involves paying your lender back and agreeing to different conditions. If you refinance, you will continue to pay a single monthly fee, but the value may differ, depending on the new terms you have agreed with your mortgage provider. A second mortgage is a new mortgage. If you have a second mortgage, you will continue to pay your first mortgage and add a second payment to your monthly outgoings. As mortgage providers often have a lien on your property, refinancing terms are preferable, as interest rates are lower.
What Types of Second Mortgages Are Available?
There are two kinds of second mortgages. These include:
- Home equity loan: this is a lump-sum payment that you can take out of the equity in your home. You will take out a portion of the stake in cash, and in exchange, the lender will secure a lien on your property. You will pay back the loan in monthly repayments in the same way as your first mortgage. Interest fees get added. In most cases, homeowners take out a second mortgage over 5-30 years.
- Home equity line of credit (HELOC): this works in a similar way to a credit card. Rather than receiving a lump sum from your lender, the second mortgage provider will offer you a credit line, which is based on the equity you have in your home. If you borrow money and then pay it back, you can reassess the total credit value. If you have a line of credit worth $10,000 and spend $2,000 and later pay it back, you’ll have access to $10,000 again. If you choose a HELOC, you must adhere to terms related to the ‘draw period.’ During the period, you’ll make minimum repayments like you would with a credit card. Once the period is over, you’ll pay back the total amount. If you’re unable to pay your loan back, the lender has the power to seize the property.
Second Mortgage Rates: What You Need to Know
Second mortgages pose more of a risk to lenders than a first mortgage because the first mortgage will be paid off as a priority in foreclosure. Due to the increased risk, interest rates for second mortgages tend to be higher than first mortgages. While the interest rates for a second mortgage might not be as competitive as a primary mortgage, this form of borrowing might be more appealing than alternative options for those who have equity. If you’re considering a second mortgage as a means to cover debts, such as credit card bills, for example, this often makes financial sense. The rates you pay for a second mortgage are likely to be lower than credit card interest charges.
Related: Benefits of Buying a Home
Why We Want One: The Up-Side
Every loan has pros and cons. If you’re considering a second mortgage, it’s always beneficial to weigh the advantages and disadvantages before making a decision. A second mortgage is likely to be more suitable for some homeowners than others. The most significant benefits include:
- Option to borrow large sums of money: if you have equity in your home, you could acquire a substantial amount of money. Lenders offer up to 90% of the equity value, giving you more money than many other types of loans. If you’ve been paying off your mortgage for a long time, a second mortgage could provide a substantial amount of money.
- Competitive interest rates: some people look into taking out a second mortgage to clear debts. In this case, interest rates are critical. Second mortgage rates are often lower than credit card interest charges, making them a viable option for individuals who want to pay off credit cards and reduce debts.
- Flexibility: one of the best things about a second mortgage is that you have scope to spend the money on whatever you want. There are no regulations or restrictions that dictate how you spend your money. You could take out a second mortgage to clear debts, pay for a new car, or send your child to college.
Why We Don’t: The Downside
Second mortgages offer many benefits to some individuals, but they are not always the best option. Just as there are pros, there are also cons.
- Higher interest rates than first mortgages: second mortgages pose a higher risk than first mortgages because the initial lease will be paid off first if payments are missed. The higher the risk, the higher the interest fees. If you’re taking out a second mortgage, you can expect the rates to be higher than your first mortgage. The lender for the second mortgage has less collateral in your property, and this will be reflected in their offer.
- Higher monthly spending: when you take out a second mortgage, you commit to an extra monthly payment, which may put more pressure on your budget. If you’re already struggling to make ends meet, it’s wise to consider your options very carefully. You don’t want to stretch your finances any further and risk getting into debt.
Why Do It at All?
If you’ve never heard of a second mortgage before, you may be wondering whether it’s worth pursuing this route. Second mortgages offer benefits for homeowners who have equity in their homes, but this is not always the only option. Before you decide, it’s wise to think about how you plan to use the money and make sure that you can afford an extra monthly repayment. Here are some common uses for a second mortgage:
Paying Off Debts
If you have debts that are costing you money, for example, credit card debts, it’s beneficial to try and pay them off as quickly as you can to reduce interest charges. Taking out a second mortgage will enable you to pay off your credit cards, eliminating the extra fees you’re paying in interest every month and replacing it with a more manageable monthly second mortgage payment. Interest fees for credit cards are often significantly higher than the rates for second mortgages, so it makes sense to use this type of loan to decrease the total value of your debts.
Covering Ongoing Expenses
If you need access to revolving credit, but you don’t want to pay high-interest charges on a credit card, a second mortgage may suit you. With a HELOC (home equity line of credit), you can access funds in the same way as a credit card, provided that you keep up with minimum repayments.
Making Home Improvements
Making improvements to your home is likely to increase the value of the property. If you take out a second mortgage, and the value of your home increases, you should be able to pay back the loan when you sell it.
A second mortgage is a means of borrowing money against the equity in your home. If you’re looking to clear credit card debts, renovate your home or put money towards a wedding or a college fund, this might be an attractive proposition. Before submitting any applications, do your research, seek expert advice, and make sure you understand the process. It’s beneficial to prepare your documents in advance and check your budget carefully. Are you ready to look at your options? Let us help.