What Homeowners Need to Know About Second Mortgages
A second mortgage -- also referred to as a home equity loan or home equity line of credit -- is just what it sounds like: another (second) mortgage on your home. Like with your original mortgage, your second mortgage is secured by your home, meaning that if you don't pay the loan, the bank can take your home. However, if you default on your home loan payments, the original mortgage will be paid off by the sale of the property first, before any money goes to the second mortgage. Second mortgages are especially appealing now because interest rates are low and home values are rising.
Here's what you need to know about second mortgages:
Types: There are two main types of second mortgages: home equity loans and home equity lines of credit. With a home equity loan, the lender gives you a lump sum of money all at once, and you repay it at regular intervals over a set period of time. Typically, the interest rates are fixed. A home equity line of credit, on the other hand, works like a credit card, so you spend the money as you need it. Typically, interest rates are adjustable.
Uses: There are few restrictions on how you can use the funds from a second mortgage. Many people use a second mortgage to fund big expenditures such as home improvements or repairs, to buy a second home or to pay off a big debt. It's generally not a good idea to use it for something frivolous such as a vacation or new clothes, because you are risking your home in the process.
Advantages: One major advantage of a second mortgage is that it may give you a large amount of money that you can spend pretty much however you want. Plus, interest rates on second mortgages are pretty low right now (though they will likely not be as low as the rate you could get on your original mortgage). Also the interest paid on these loans may be tax deductible; please consult your tax adviser.
Disadvantages: The major downside of a second mortgage is that the loan is secured by your home, so you can lose your home if you don't repay the loan. Plus, you may have to pay significant fees to get a second mortgage (usually closing costs are 3-6 percent of the total loan amount), and your interest rate might not be that great, especially if you don't have a good credit score.
How much money borrowers can get: The amount of money you can get depends on a number of things, such as the amount of equity you have in your home, your credit score and the loan-to-value ratio (this is the percentage of the property that is mortgaged). Most lenders will not lend you any more than 75 to 85 percent of the loan-to-value ratio of your first and second mortgages combined.
Where to get a second mortgage: You don't have to get your second mortgage with the lender that gave you your original mortgage; you can get a second mortgage with pretty much any lender. The important thing is to get a variety of quotes, including interest rates and total fees, and compare them.