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Second Mortgage: How does it Work?
When planning to take out a second mortgage, it is essential to understand how it works and its advantages and disadvantages. That will not only give you a sense of clarity but also help you to find the best mortgage rates in the market.
Whether you are planning to fund your children’s education, renovate your home, buy a new home, or consolidate your debts, a second mortgage can be helpful. However, you must have enough home equity for you to qualify for the loan.
In this article, we’ll look at the definition of a second mortgage, how it operates, and its pros and cons. You will also get to understand the uses of the second mortgage.
What is a Second Mortgage?
A second mortgage is a loan that allows homeowners with an existing mortgage to borrow money against their home equity. It means that the home, which is an asset, acts as collateral. With a second mortgage, you can use the money to finance several expenses.
While the second mortgage allows you to cash out money from your home equity, it must be worth it. You cannot borrow more than the home equity that your house has accumulated. Home equity is your home's market value less your outstanding mortgage balances.
If you don’t have enough equity in your home, you can still increase it by making your monthly mortgage payments on time to reduce your outstanding loan balance. Your home may also appreciate with time and translate to higher home equity.
How a Second Mortgage Works
As one of the quickest ways of getting funds, a second mortgage uses your home equity to evaluate what you ought to borrow. You must own home for you to be eligible for the loan. The home serves as security, and your lender may seize it if you default payments.
Forms of Second Mortgages
You can take out a second mortgage as a line of credit, lump sum, or based on mortgage rates.
1. Line of Credit
When using a home equity line of credit to outsource funds, your lender determines the maximum amount of money you can borrow. You don’t have to take out the entire cash, but you can always withdraw it in bits when a need arises.
2. Lump Sum
As the name suggests, your lender would offer you a one-time mortgage depending on your home equity. You can use the money to fund any project so long as you make your monthly payments on time. The fees also include interests.
3. Mortgage Rates
A second mortgage can have a fixed interest rate or variable interest rate. With the fixed-rate mortgage, you will make the same monthly payments until the loan is fully paid off. But with the variable-rate mortgage, your monthly payments change with time.
How to Qualify for a Second Mortgage
While home equity plays a significant role in determining your eligibility for a second mortgage, lenders may also consider other factors to approve your loan application. Such factors include your credit score and history, property taxes, and sources of income.
You must have a good credit score to qualify for a low-interest mortgage. Your source of income should also be reliable to avoid defaults of monthly payments. While reviewing your application, the lenders must also check if your property taxes are due.
Costs of a Second Mortgage
Second mortgages can be relatively expensive due to the various costs associated with it. The expenses vary depending on the types of lenders but always fall within the same range. Second mortgage rates are often higher than primary mortgage rates because they involve high risks.
Before taking out a second mortgage, you should request your lender to give you every information regarding the costs involved. Some of the fees that you may pay include origination fees, broker fees, and appraisal fees. You may also have to pay the closing costs, and they can always be high.
Advantages of Second Mortgages
Second mortgages can be helpful in times of need. They come with numerous perks that are promising. Now, let’s look at some of the benefits it brings forth to homeowners.
1. Funds Various Projects
Unlike the primary mortgage, a second mortgage can be used to finance many expenses such as education, family parties, weddings, birthday parties, and home renovation. You can borrow any amount of money so long as it is within the mortgage limit.
2. Tax-Deductible Interest
Some second mortgage lenders may offer tax-deductible interests to homeowners. With a HELOC or a home equity loan, you can get a deduction of up to $100,000 of your mortgage.
3. Lower Interest Rates
Second mortgages always offer loans at lower interest rates compared to other debts like the payday loans and credit cards.
4. Higher Loan Amounts
By using your home as collateral, you can borrow high amounts of cash when you have higher home equity. Most lenders allow you to cash out up to 80% of your home's appraisal value.
5. Limited Documentation
When taking out a loan, lenders would ask you to provide every document that proves that you own the asset you are using as collateral. Such materials may include financial statements and a notice of assessment. Second mortgages do not require such documents.
Disadvantages of Second Mortgages
Every product that has benefits may also have specific sets of drawbacks, and second mortgages are not an exception. Here are some of the cons of a second mortgage.
1. Higher Costs
Second mortgages have many expenses that can be collectively very high. You may have to pay fees such as the appraisal fees, origination fees, and the closing costs.
2. Higher Interest Rates
Second mortgages may have lower rates than credit cards, but they are relatively higher than the rates for first mortgages.
3. Higher Risk of Losing Your Home
If you fail to make mortgage payments on time, the lenders may seize your home and sell it off to recover their money.
Before taking out a second mortgage, it's vital to shop around to find lenders that offer the best mortgage rates. You can get the loan from a local bank, credit union, mortgage broker, or an online lender. With the help of this website, you can find the best second mortgage lenders in the market.