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Spreading the cost of a big purchase or expense with a personal loan is generally preferred over paying out a lump sum of cash. However, the interest rate you get on the personal loan is key to it being affordable. Unfortunately, if you have a bad credit score qualifying for a low-interest rate can be difficult.
But, if you own a home or property, you can qualify for credit for very low-interest rates using a second mortgage, no matter what your credit score is.
You can tap into your home equity through a few different lenders, such as banks, credit unions, and alternative lenders. While banks may have the most competitive rates, qualifying for one with bad credit or poor finances is difficult.
Alternative lenders, on the other hand, can provide you with relatively affordable interest rates without all the stringent requirements. In fact, so long as you have a certain amount of equity in your home, you may qualify.
Personal Loan | HELOC | Home Equity Loan | |
Type Of Loan | Fixed Installment | Revolving | Fixed Installment |
Interest Rate | Fixed (3% to 46%) | Variable (Interest Rate +/- Prime) | Fixed (3% to 6%) |
Term Lenght | 3-months to 5 years | 5 to 25 years | 5 to 25 years |
Loan Amount | Up to 35,000 (varies by lender) | 65% to 80% of your home’s appraised value | 80% to 95% of your home’s value. Based on lender and mortgage balance. |
How Are Funds Accessed? | One lump sum | As needed | One lump sum |
Requirements | Credit score Income Debt to income ratio | Credit score (not always required) Income Debt-to-income ratio | Credit score (not always required) Income Debt-to-income ratio |
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.
There are two common kinds of second mortgages: home equity loans or home equity lines of credit (HELOCs).
Generally second mortgage rates are lower than unsecured personal loan interest rates. The security provided by a second mortgage reduces your risk as a borrower, which leads to lower rates. 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.
When deciding on a rate with your lender, you will often have the choice of either a fixed rate or a variable rate.
To apply for a second mortgage, follow these steps:
You can apply for a second mortgage with the same lender that holds your first mortgage. But you may also consider applying with a different lender, especially if you can get a better rate and terms. It’s best to do a little comparison shopping for a second mortgage before settling on a specific lender to make sure you’re getting the best deal.
Along with your application, you’ll need to supply the lender with certain documents to prove your identity and verify your financial health. For instance, your lender may request any of the following documents:
Lenders typically send in a professional appraiser to get an accurate estimate of the current value of your home since second mortgages are based on your equity in the property.
Before you can get approved for a second mortgage from a traditional lender (bank or credit union), you’ll need to undergo a stress test. This ensures that you’ll still be able to cover your mortgage payments if interest rates increase in the future.
However, private or alternative lenders are not federally regulated, which means they’re not required to conduct a mortgage stress test on loan applicants. So if you’re finances aren’t up to bank standards, you can still qualify for a second mortgage with these lenders.
Once approved for a second mortgage, you’ll have to pay closing costs for the loan. You’ll then receive the funds from your second mortgage in one lump sum, then make repayments as per your loan agreement.
There are a variety of factors that can increase or lower your second mortgage rate, including the following:
Your equity is the amount of your house you actually own. This could be 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 credit score can help you qualify for the best second mortgage rates, however, it’s not always a requirement. Many lenders offer low rates regardless of your credit health. That is, as long as you have equity in your home and your overall finances are in good shape.
That said, your interest rate is likely to be lower if you have a good credit score. If you think your credit could be better, you should consider improving your credit score before applying for a loan.
Using the equity built up over time in your first home, you can take out a second mortgage to finance other big purchases. 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:
The amount of money you can borrow with 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.
Here’s an example of how to calculate how much you can borrow with a HELOC
Current Value Of Your Home | $800,000 |
Outstanding Mortgage | $500,000 |
Maximum HELOC Limit (80% of your home’s value) | $640,000 ($800,000 x 80%) |
How Much Can You Borrow (Max HELOC limit – Outstanding mortgage) | $140,000 ( $640,000 – $500,000) |
Like all investments, taking out a second mortgage comes with pros and cons:
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 an investment property.
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