Too often, homeowners are not aware that they can take a second mortgage on their homes. The first mortgage, usually taken as the primary option when buying the house, is called the “first” or “primary” loan. A secondary loan against the same property while your Primary Mortgage is still unpaid consists of what’s known as a Secondary Mortgage.
A second mortgage may give you immediate access to funds that would otherwise be inaccessible. A second mortgage can help pay for tuition, high-interest debts, home renovation projects, or even medical expenses when faced with an emergency. Similar to a first mortgage, a second mortgage is most beneficial when its terms are favorable and it’s paid off as quickly as possible in order to avoid paying unnecessary interest expense.
To get the most out of your investment, start by learning about how second mortgages work and what conditions you must meet in order to receive one.
What Are Second Mortgages?
A second mortgage is secured by your equity and is an extension of your primary mortgage (i.e. first-time mortgages). Second Mortgages allow you to borrow a portion of your home’s equity as cash. The amount you can withdraw from a second mortgage depends on how much equity you have built up and both primary and second mortgages cannot exceed 80% of the property’s value.
Interest rates on second mortgages will be higher than the rates on your current mortgage. The rate will be higher because it has an increased risk of default, but this type of loan can still help out financially if managed correctly.
How Does a Second Mortgage Work?
Second mortgages provide a way to withdraw cash from the equity you have in your home. To calculate how much of your equity is available, you figure out what’s left based on the value of your house and its assessed value, then deduct what you owe on your first mortgage. The lender will ensure that the primary and secondary mortgage do not exceed 80% of the total value of your home.
You must make two payments each month, one for the primary mortgage paying down the remaining principal balance and another for the second mortgage. Secured by your home’s equity, a second mortgage loan is only as good as your comfort level in using that collateral. Defaulting on the first would lead to foreclosure, so the lenders for a second mortgage charge higher interest rates for taking on additional risk.
A HELOC Is A Type Of Second Mortgage.
HELOCs are secured revolving loans using your home as collateral. Similar to a credit card, a Home Equity Line of Credit allows borrowers to borrow up to 85% of the value of their home and pays back fixed payments with variable interest rates based on Prime rates.
Benefits Of Second Mortgages
Since there are many providers for mortgages, second mortgages offer a variety of options. They can provide alternatives to refinancing in order to save fees and even help you access your funds in one lump-sum payment. Another advantage of a second mortgage is that you are not required to discharge your first mortgage and suffer the penalties.
Second mortgages usually are interest only payments with terms ranging from 1 year up to 25 years.
Drawbacks Of Second Mortgages
A major drawback for second mortgages is the higher interest rate they have opposed to the rates on the primary mortgage this can lead to the increased risk of foreclosure. Second mortgages can trail the primary mortgage when it comes to risk and rewards, but they are helpful for consolidating credit card or other revolving debt.
Amortizations on secondary loans can span up to 25 years of repayment, but these rates are often lower than those found in other loan types. Rates for amortizing loans are also generally lower than those offered by credit cards or unsecured lending.
How To Qualify For Second Mortgages
A lender will have a specific set of requirements for approval in order to get a second mortgage. These requirements are divided into four categories: equity, credit score, income and property you qualify for.
1. Equity
For the HELOC, at least 20% equity is needed. For a lump sum second mortgage, 10% equity is enough but more will boost your chance of qualifying.
2. Income
When applying for a home loan, lenders will often require you to have a stable income. They’ll ask for bank statements and pays stubs to verify your income.
3. Credit Score
Your credit score will have a direct impact on the interest rate and fees you’re offered with your second mortgage. You can qualify for one even if your credit score is 500, but having a higher credit score will mean lower rates.
4. Property
Second mortgages keep your property as collateral because they pose a higher risk to lenders. An appraisal is often required before approving the loan.
The Bottom Line
A second mortgage can be a way to meet your financial goals of; paying off debt, putting children through university, making home renovations or buying property. The best way to ensure that a second mortgage is beneficial for you is to determine what your budget will be and what you would do if you defaulted on your home.
Once you understand the basics of second mortgages, you can compare rates from different lenders to find the best one for your needs.
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