Sometimes, you just need a big lump sum of money. Life can get expensive, and you may suddenly you find yourself needing hundreds of thousands of dollars. Maybe it’s medical bills that need paying, consolidating your debt, a desire to renovate or improve your home, or paying for your child’s college tuition.
When it comes to getting massive amounts of money fast, one of the few ways to do it is to take out a second mortgage on your home. This is different from getting a mortgage to purchase a second home, like a vacation home or investment property, although the term “second mortgage” is sometimes used in these situations as well. Normally though, a second mortgage refers to taking out a secured loan, using your home as collateral. If you are considering a second mortgage, here’s some things you need to know before signing the contract.
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What is a Second Mortgage?
A second mortgage is a secured loan that uses your home as collateral. You have to own the home, but you can still take out a second mortgage even if you are still paying off your first mortgage. There are two primary types of second mortgages: home equity loans and home equity lines of credit.
Second Mortgage vs Home Equity Loans
Technically, a home equity loan is a specific type of second mortgage, rather than an alternative to taking out a second mortgage. The way a home equity loan works is by requiring that you first need to own a home and owe less on it than the home is worth, also known as “equity.” You can then approach a lender for a home equity loan, using your home, and your current equity, as collateral. A home equity loan is paid out in a single lump sum and then is paid back like any normal loan. Typically, you can only earn a loan for how much equity you have, meaning if you haven’t had a home for long, there might not be a lot of money to borrow.
The benefits of a home equity loan are: lower interest rates, easier approval process, and quicker access to the money. The downside is that abusing home equity loans can lead to massive debts and losing your home. It’s also expensive to take out a home equity loan, sometimes costing thousands of dollars in closing costs and fees.
Second Mortgage vs HELOC
A Home Equity Line Of Credit (HELOC) works by opening up a line of credit connected to the equity of your home. While it still uses your home as collateral, it isn’t quite the same as a home equity loan. It works a lot like a credit card on steroids, where instead of getting a lump sum, you are able to withdraw and pay off money when needed. You also don’t have to pull out the max amount, just use what you need at any given time during the draw period. Then, you can pay off the debt you do use either in the next month or in installments with interest. If you pay back the debt, the credit becomes available again, making it a form of revolving credit.
The downside to HELOC is that interest rates are variable, meaning they can go up and down each month. That could result in having to pay a lot more on a payment than expected, or having a high interest rate for a long period of time.
How Does a Second Mortgage Work?
Second mortgages utilize a person’s home as collateral, meaning if they fail to pay the loan, the lender or bank can seize the home and sell it to make back their money. Typically, people who take out a second mortgage understand the financial debt they are taking on. Lenders are willing to give out second mortgages because, for them, there is very little risk in the loan. If the mortgage holder fails to pay back the loan, they can get some or all of the money back by foreclosing on and then selling the home.
Second Mortgage Rates
Interest rates are an important consideration when looking at second mortgages. Home equity loans traditionally have low interest rates, similar to those in a first mortgage. If you have good credit and a history of paying on time, your interest rate is going to stay pretty low.
With a HELOC, interest rates are variable and can go up and down based on a financial benchmark, such as the Wall Street Journal Prime Rate.
How to Get a Second Mortgage
If you feel like you need to get a second mortgage, whether to pay for outstanding debts or cover new expenses, start by figuring out what kind to get. For a large, one time payment or to consolidate current debts, a home equity loan is a good idea. If you have large recurring payments, like paying tuition, a HELOC might be what you want.
Once you decide what to go with, start getting a statement of your home’s current equity. That includes how much you’ve paid on the home and if it increased in value. You might need to get your home appraised to fully understand your equity. Then, approach either your current mortgage lender or a new lender asking for a second mortgage. Shop around for the best rates and what matches your needs.
The mortgage lender will analyze your home’s equity and your credit score to determine if you qualify for a second mortgage. If everything goes smoothly, you should be able to obtain your second mortgage is a reasonable amount of time. Be sure to look over the paperwork, fully understand the terms of the loan, and what would need to happen for the lender to be able to take your home as payment.
Whenever dealing with loans, especially massive ones like a second mortgage, you need to budget out your finances and be positive you can take on the extra expenses. Failing to pay off your second mortgage will result in losing your home and all of the equity you’ve built, alongside a major blow to your credit score. That means starting over, likely taking years of rebuilding finances and credit in order to buy a new home. Instead, just be sure you can handle the second mortgage payments or don’t take out the mortgage.
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