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There are many sources one can use as security when taking out a loan. Some may put up stocks or bonds; others may have a luxury car to put up as collateral. But, if you own a home or property, you have a valuable source of credit.
Second Mortgages Explained
Second mortgages are loans taken against a home that already has a mortgage on it. In the case of a second mortgage, you are using your own home as collateral for the loan.
Using the equity built up over time in your first home, you can take out a second mortgage to finance other big purchases with solid collateral. Some investors will take out a second mortgage in order to secure a down payment for a second property. Other uses for a second mortgage include paying for the following:
- A child’s university or college tuition
- Consolidating high-interest debt
- Financing living costs after a job loss
- A down payment for a second property
- Expensive medical treatment (not covered by insurance)
- Home renovations
There are two common kinds of second mortgages: home equity loans or home equity lines of credit (HELOCs). Home equity loans are close-ended loans borrowed and paid back over time. HELOCs are open-ended loans that are borrowed against a homeowner’s home, paid back, and continuously borrowed if necessary. A HELOC IS similar to a personal line of credit or a credit card except there is collateral involved.
How Much Can You Borrow Through a Second Mortgage
The amount of money you can borrow through a second mortgage is dependent on a few factors: your loan to value ratio (LTV), your home’s total value, and your credit score. While different lenders have different rules around the loan to value ratio that they will lend within, most prime lenders will only allow you to borrow up to 80% of your home’s value.
Let’s take a look at an example of what you can borrow with a HELOC if you owned an $800,000 home, assuming you’ve paid off 300,000 in mortgage payments and interest.
Value of your home: $800,000
Maximum loan permitted: 80%
Loan amount based on home value: $640,000
Minus the balance owed on your mortgage: $500,000
Second mortgage credit limit: $140,000
Where Can You Get a Second Mortgage?
Getting a second mortgage is not as easy as getting a first mortgage. Although you are able to borrow from a few different lenders, such as banks, credit unions, and alternative lenders, you are likely to face extremely high-interest fees with an alternative lender, as there aren’t as many of them available for a second mortgage. Banks and credit unions are the best choices in terms of interest rates for second mortgages.
Second Mortgage Rates
|Chip Reverse Mortgage||Reverse Mortgage||3.89.% – 4.84%||Learn More|
|Canwise Financial||Home Equity Line of Credit||4.45%||Learn More|
|Prudent Financial Services||Home equity Line of Credit||5.75% – 9.9%||Learn More|
|Alpine Credit||Home Equity Loan||varies||Learn More|
|Leap Financial||Home Equity Loan||varies||Learn More|
What Kind of Rate Can You Get With a Second Mortgage?
Like most loans that have collateral, interest rates tend to be lower than that of a credit card or unsecured line of credit, for example. However, it’s important to note that a second mortgage always has a higher interest rate than a first mortgage. This is because the lender assumes more risk on a second mortgage than the first. If a borrower defaults on the loan or fails to pay it back, the first lender (first mortgage) always gets paid out first. The second lender takes more risk than the first lender because the chance of being paid out on time is lower than for the first lender or mortgage.
Fixed and Variable Rates
When deciding on a rate with your lender, you will often have the choice of either a fixed rate or a variable rate. Fixed rates are constant rates that do not change for an agreed-upon period of time. For example, a lender might offer you a fixed rate of 2.8% for 5 years. A variable-rate changes with the market. This means that you could start with a more competitive rate, let’s say 1.8%, but it also means that the rate can skyrocket with the market.
Factors That Affect Your Second Mortgage Rates
There are a variety of factors that can increase or lower the rate of interest on your second mortgage:
Your equity is the amount of your house you actually own. This could the amount of your mortgage you’ve paid off or it could be higher if the value of your home has increased. For example, if you have a home worth $600,000, and you have paid approximately $100,000 of your mortgage, you have $100,000 in equity in that home.
You’ll need to provide proof of income to ensure your lenders have faith in your ability to make your monthly payments. Generally, you will have a better chance of securing a lower interest rate if your income is high.
Your interest rate is likely to be lower if you have a good credit score. If you think your credit could be better, working to improve your credit score should be a top priority.
Your property acts as collateral if you take out a second mortgage. This assures lenders that their investment is secure in the event that you are unable to make your repayments.
Pros and Cons of a Second Mortgage
Like all investments, taking out a second mortgage comes with pros and cons:
|Access to Equity: If you own a home without a second mortgage on it, that means you may have hundreds of thousands of dollars in un-accessed equity. Taking out a second mortgage gives you access to that equity, and allows you to pay off debt or make other big purchases.||More debt: Second mortgage often means close to doubling your original mortgage payments. It’s important to assess your budget before deciding to take on this extra debt.|
|Paying Off Debt: Accessing your home’s equity can allow you to pay off your debt, indirectly increasing your credit score.||Low LTVs: Second mortgages attract lower loan-to-value (LTV) ratios than first mortgages. With a second mortgage, you often won’t be allowed to borrow as much money as you could on your first home.|
|Refinancing Alternative: Second mortgages provide alternatives to refinancing, which can help you save on a variety of fees like exit fees and legal fees.||High Costs: Second mortgages usually have higher fees and interest rates than first mortgages.|
|Home Renovations: Home renovations can be quite costly, and accessing your home equity can help you cover those costs.||Limited Choice of Lenders: Alternative lenders are not as likely to lend a second mortgage to you. You’ll often find that A lenders, or banks, are the more common lenders for second mortgages.|
|Tuition: Second mortgages have been taken out to cover school tuition payments.|
|Medical Expenses: If your insurance doesn’t cover hefty medical expenses, a second mortgage can help in emergency situations.|
Before taking out a second mortgage, make sure you assess the risks involved and carefully plan your budget before making any decisions. With enough planning and research, a second mortgage can help you pay off debt, put your children through university, or even put a down payment on a second property.
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