The Ins and Outs of a Second Mortgage

Maybe you’ve thought about renovating or repairing your home but have wondered where you can possibly come up with the extra cash. Accessing your home’s built-up equity by taking out a second mortgage may be a viable option but it does come with some advantages and disadvantages. Let’s take a look at the ins and outs of a second mortgage.

Home Equity Defined

The amount of equity you have in your home determines the amount of money you can take out as a second mortgage. You can calculate your home’s equity by subtracting the amount you’ve paid on the principal balance of your mortgage from the total amount of funds you’ve borrowed. According to Rocket Mortgage, “If you bought a home worth $200,000 and you’ve paid off $60,000 worth of equity including your down payment, you have $60,000 worth of equity in your home. The interest you pay doesn’t count toward your home equity.” Home equity can also rise as with home improvements or fall due to housing market conditions.

Second Mortgage Defined

When you currently have an original or first mortgage in place, you may be able to access the equity in your home through a subordinate or second mortgage using the same property as collateral. Essentially it’s an additional loan on top of the mortgage you already have and acts as a lien against the equity you’ve already accumulated in your home. Just as with your first mortgage, a second mortgage allows the lender to take possession of your home if you default on your mortgage payments. You don’t need to use the same lender when you’re trying to obtain a second mortgage so be sure to shop around for the best rates as offered by banks, credit unions, and mortgage brokers.

How Much Can You Borrow Through a Second Mortgage?

Every lender will have specific second mortgage requirements but generally, you may be able to borrow up to 90% of the equity in your home. You’ll also likely need a debt-to-income ratio of 43% or less and a minimum credit score of 620. Lenders will also check your income history, as well as to ensure you’ve been making your primary mortgage payments on time.

Second Mortgage Types

Most lenders offer two types of second mortgages to choose from:

  • Home Equity Line of Credit: also known as HELOC, a line of credit is granted based on your home’s equity. It’s basically like a credit card where you’re given a spending limit and then can do as you please with the funds as long as you pay it back by making regular minimum monthly payments.
  • Home Equity Loan: this provides you with a lump-sum payment borrowed against the equity in your home. Terms can range anywhere from 5to 30 years and you’re required to pay monthly installments with interest.

Refinance or Second Mortgage?

When you refinance a mortgage with your lender, you’ll be paying off your first mortgage and replacing it with an entirely new loan offering new terms. When you obtain a second mortgage, you’re adding an entirely new mortgage payment into your financial mix on top of paying your first mortgage.

Advantages of a Second Mortgage

  • you can access a large amount of money depending upon the equity you’ve built up
  • interest rates are significantly lower for second mortgages vs other high-interest debts
  • you can use your second mortgage money for any reason you’d like including travel, vehicles, home improvements, or consolidating and paying off debts such as credit cards or student loans
  • a second mortgage home equity line of credit can be a viable option if you only need to access funds periodically
  • if you used your second mortgage money for substantial improvements to your home, you may qualify for a mortgage interest rate deduction through the Tax Cuts and Jobs Act
  • you may be able to use a second mortgage as a way to lower your first mortgage’s loan-to-value ratio to get it at 80% or below which means you won’t have to pay for private mortgage insurance
  • interest rates for a second mortgage will be higher than your first however they’ll be substantially less than those for credit cards or personal loans

Disadvantages of a Second Mortgage

  • the risk of foreclosure is higher as if you can’t meet the financial obligations that come with carrying two mortgages and stop making payments, the lender will seize your home
  • mortgage interest rates will be higher for second mortgages as there’s an increased risk for the lender because if you foreclose, the second lender only receives money after the first lender has been paid
  • you’ll be required to make two monthly mortgage payments: one for your original mortgage and an additional payment for your newly acquired second mortgage. This can quickly become a household strain depending upon your financial circumstances
  • be prepared to pay for closing costs, appraisals, credit checks, and processing/origination fees that you’ll either need cash for upfront or by rolling these costs into your second mortgage

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Author – Connie Motz