Are you in need of a lump sum of cash to cover a financial emergency, make costly home repairs, pay off high-interest debt or make some other big-ticket purchase? If you have a sizable amount of equity in your home, a second mortgage could be an option.
You can get funds much quicker through a second mortgage than by saving enough money. But how do they actually work, and where can you find these loan products? Keep reading to learn the answers to these questions and more to discover if a second mortgage is right for your financial situation.
What is Considered a Second Mortgage?
A second mortgage is a loan product that puts a lien against the portion of your home that’s already paid off. Your home becomes collateral for the loan, but no issues will arise if you continue making the monthly payments. You’re free to use the proceeds you get from the loan however you want, and they often come with competitive financing terms.
Second Mortgage vs. First Mortgage: Differences
When you take out a second mortgage, you make two separate monthly payments – one to your current lender and another to the second lender. And in the unfortunate event that your home is foreclosed, the second mortgage lender is only compensated after the first lender. Therefore, before getting a second mortgage, you should consider if you have the financial flexibility to consistently make two monthly loan payments.
Second Mortgage vs. Refinancing: Differences
Refinancing your home involves swapping out your current mortgage for a new one with different terms. The new lender pays off your existing balance, and you begin making monthly payments with the new lender.
A second mortgage doesn’t quite work this way, though. As mentioned above, it’s a separate loan product, which means you are obligated to make two monthly payments. However, you get to keep the terms on your current loan instead of receiving a new interest rate and changing the loan’s duration. Homeowners who secured their homes with low interest rates will be more cautious about a refinance as interest rates go up. A second mortgage lets these homeowners preserve their more favorable loan terms and still get additional financing.
Reasons Why You May Want to Get a Second Mortgage
Wondering if a second mortgage is right for you? Here are some of the reasons this financial product may work for you:
You Have a Lot of Equity in Your Home
Having more equity in your home increases the maximum loan amount. For example, if you recently bought your home with a 20% down payment, you cannot borrow as much capital with this strategy. Having a lot of equity in your home also means the first mortgage will get paid off sooner. Borrowers must consider their ability to make two monthly mortgage payments before the first one gets paid off.
You Cannot Qualify for a Cash-Out Refinance with Better Terms
A cash-out refinance changes your existing loan, but that transition can result in a higher interest rate, even if you have good credit. A low credit score will make it even more difficult to get better terms on a refinance than the ones you have with your current mortgage. A second mortgage still gives you the capital you need, but you get to preserve your first mortgage’s terms.
You Want to Consolidate Your Debt
A second mortgage typically features a competitive rate since it uses your home as collateral. You can use the capital from your second mortgage to pay off smaller financial obligations with higher interest rates. Credit card debt is a prime target for debt consolidation. Many credit card issuers have interest rates beyond 20%, but interest rates on second mortgages are much lower. Some people use a second mortgage to only pay off credit card debt, but if you have similar obligations, you can group them together into a single loan.
You Want to Access a Revolving Line of Credit
A revolving line of credit is a useful backup in case you need funds for an emergency. Other than origination fees and other administrative costs, you won’t have to pay for a line of credit until you borrow against it. Then, when a large expense comes up, you can immediately tap into your line of credit instead of waiting for a lender to approve your loan application.
You Plan on Using the Funds for Home Improvements
Home improvements can increase your property’s value and functionality. A renovation can make your home more enjoyable, and you will build your equity position in the process. A second mortgage gives you the capital you need to make immediate improvements instead of saving cash for years to cover big projects. By the time you have the cash lined up in your bank account, prices could have increased considerably.
How Much Can You Typically Borrow with a Second Mortgage?
The amount of equity you have in your home plays a major role in how much a lender will allow you to borrow with a second mortgage. To determine the amount of equity you have, subtract the remaining balance of your mortgage from the current value of your home.
Most lenders let you borrow up to 80 percent of the equity you’ve built up. So let’s say your home is currently worth $375,000, and you owe $215,000 on your home loan; you could be eligible for a second mortgage of up to $85,000 ($375,000 * .80 – $215,000).
Common Types of Second Mortgages
Home Equity Loan
You can use this type of loan to convert a portion of your equity into cash. The loan proceeds get disbursed as a lump sum and are payable with a fixed interest rate over an extended period – typically 5 to 30 years. Opting for a longer loan term reduces your monthly payments but increases the total interest on your loan.
Home Equity Line Of Credit (HELOC)
A home equity loan is very similar to a HELOC in that it lets you tap into your equity. But instead of receiving the funds at once, you can borrow what you need from a line of credit with a preset limit on an as-needed basis. It works like a credit card, and you’re able to keep making payments and reuse the funds as often as you’d like until the draw period ends. Home equity lines of credit have variable rates like credit cards, but they have much lower rates. Some people use HELOCs to repay credit card debt so they can contend with a more favorable rate.
Things to Consider When Acquiring a Second Mortgage
Loan Purpose
A benefit of second mortgages that makes them stand out among other debt products is that you have the freedom to use the funds for any purpose. Of course, you should know the purpose before you request a second mortgage, but you do not have to tell the lender.
Borrowing Limits
Although many lenders impose a borrowing limit of 80 percent of your home equity, some will allow you to pull out as much as 90 percent for a second mortgage. Depending on how much equity your home has, this could be far more than you’ll find with personal loan products. A second mortgage may also have a lower interest rate than a personal loan since the second mortgage uses your home as collateral.
Approval Times
It varies by lender, but you can expect it to take anywhere from 30 to 45 days to close on a second mortgage. The process you have to go through is basically the same as when you applied for your current mortgage, and the underwriting and approval process could be longer if there are hiccups along the way. You can get a quicker approval time with an online lender than with a financial institution. If you need an accelerated time frame while still getting competitive rates, an online lender may be a good idea.
Costs
Borrowing costs for second mortgages are generally higher than what you’ll find with primary mortgages. This is due to the elevated risk posed to lenders. So, if you’re considering a second mortgage to consolidate and pay off high-interest debt, a cash-out refinance could make more financial sense. However, if a cash-out refinance forces you to accept a higher interest rate than your original mortgage, a second mortgage may be the better choice. You should also consider how far you can stretch out the loan, as a lengthier loan duration will minimize your monthly expenses.
Cash-out Refinance: An Alternative to Second Mortgages
A cash-out refinance allows you to tap into the equity of your home and convert it into usable funds. By refinancing your existing mortgage, you can access the value that has built up in your property over time. This provides an alternative to taking out a second mortgage or other forms of borrowing.
One of the key advantages of a cash-out refinance is its flexibility. Unlike a second mortgage, which typically comes with its own set of terms and conditions, a cash-out refinance allows you to consolidate all your debts into one single loan payment. This makes it easier to manage your finances and potentially save money on interest payments.
In addition, a cash-out refinance gives you the opportunity to invest in your home and increase its value. Whether you want to make necessary repairs or renovations, upgrade your appliances, or even add an extension, the funds from a cash-out refinance can be used for these purposes.
