Homeowners who have enough equity in their homes can take on second mortgages. Getting a second mortgage can be beneficial to someone who might need to use the money to pay off outstanding debts or remodel their home. At the same time, it can also be a risky move. Before you start your application, we’ve got the lowdown on everything you need to know about second mortgages.
What Is a Second Mortgage?
Homebuyers who can’t pay for their homes up front usually opt to get mortgages. Once a homeowner has made significant progress toward paying off the first mortgage, he or she can try to get approved for a second mortgage. A second mortgage is just an additional home loan that someone can take on to get access to more financing.
Second mortgages come in two different flavors: home equity loans and home equity lines of credit. Both let homeowners borrow against their home equity.
Home equity loans are second mortgages that usually come with fixed interest rates, although some have variable rates. When you take out a home equity loan, you get the entire loan amount at once.
A home equity line of credit (HELOC), on the other hand, works more like a credit card. Instead of getting a lump sum payment, you’re able to borrow what you need when you need it, up to your credit limit. HELOCs come with adjustable interest rates (meaning that the interest rate you’re charged will vary). You’ll use a credit card or write a check to get the money from your HELOC and then you’ll make monthly payments to pay off the debt like you would with a credit card.
Unlike first mortgage loans, which typically come with 15-year or 30-year loan terms, home equity loans and HELOCs are normally paid off relatively quickly. While they can have 30-year terms (particularly if they’re fixed-rate home equity loans), these mortgages tend to have repayment periods lasting for five to 15 years.
How to Get a Second Mortgage
Many lenders offer second mortgages, so you can choose a second lender if you don’t want to use the same bank, credit union or online lender from your first home loan. Comparing lenders is a good idea if you want the best mortgage rates and terms.
Applying for a second mortgage isn’t that different from applying for a primary home loan. You’ll go through an underwriting process and your lender will look at your credit and your financial track record. If your credit score is in good shape and you meet your lender’s requirements, you might qualify for a loan worth as much as 85% of your home equity.
The Benefits of Second Mortgages
What’s great about second mortgage loans is that you can use them to fund a variety of projects. The kind of second mortgage that’s best for you depends on how much money you need and what you plan to use your loan for.
If you need a specific amount of money for a one-time expense – like $6,000 for a family member’s retirement party – it might make more sense to get a home equity loan rather than a HELOC. Home equity loans are also useful for homeowners who need a large amount of financing to consolidate other loans or help their kids pay for college.
But if you’re not exactly sure how long you might need financing or you’d like to borrow different amounts of money from month to month, you’d probably be better off with a HELOC. You can use a HELOC to make payments over time if you’re working on a small home renovation project or you have to pay for a series of emergencies.
Another advantage of having a second mortgage is the fact that your mortgage interest can be tax-deductible. If you have a home equity loan or a HELOC, you might be able to get a deduction for up to $100,000 of that debt or the amount of equity you hold in your home (depending on which is smaller).
Downsides of Second Mortgages
Before you take on a second mortgage, it’s important to consider the drawbacks of getting one. Ultimately, you’ll have to pay back the funds you borrow. Since your home acts as your collateral (meaning that it secures your loan), your lender can force you into foreclosure and take your house if you fail to pay off your second mortgage.
Second mortgages are subordinate to primary mortgages, so if you default on your loans, the debt from your first mortgage gets paid off before the second mortgage lender receives anything. For that reason, home equity loans and HELOCs are a bit riskier than traditional home loans. Therefore, they typically have higher interest rates.
In addition to the higher mortgage rates, there are additional fees that you’ll owe if you want a second mortgage. Closing costs for second mortgages can be as much as 3% to 6% of your loan balance. If you’re planning to refinance, having a second mortgage can make the whole process trickier to navigate.
Home equity loan payments are generally easier to manage because you can set up your budget knowing that you’ll pay x amount of money every month for that second home loan. Since the amount you owe for a HELOC will vary, however, you might not be able to pay your bill if it’s significantly more expensive than it previously was. And if you need a second mortgage to pay off existing debt, that extra loan could damage your credit score and you could be making payments to your lenders for years.
Getting a second home loan is a serious undertaking, especially because you risk losing your home if you can’t keep up with your mortgage payments. If you’re set on applying for one, it’s best to proceed with caution and think about the problems you could face from taking on additional debt.
Financial Planning Tips for Homeowners
- Planning ahead for your home purchase is critical for your long-term financial plans. A financial advisor can help with this. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Building a financial plan for you and your family can ease the financial stress that comes along with getting a mortgage. Read through SmartAsset’s guide to building a family financial plan to learn more.
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