How Do Second Mortgages Work?

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Are you looking for a second mortgage but have no idea how it works? Simply put, it is a type of home loan taken in addition to the original mortgage. Compared to the first or original mortgage, it gives more independence to the borrower with lower interest rates. 

But there’s more to it that you probably don’t know yet. This article will tell you everything about second mortgages and how they work.

What Are Second Mortgages?

Any loan taken against your house when a previous loan is active is called a second mortgage. However, it is a separate loan and isn’t merged with the original mortgage payments. 

It is meant explicitly for homeowners and allows them to borrow against the equity of their homes without any hassles of refinancing. You can get a maximum of 85% of your home value as your second mortgage. However, most lenders expect about 20% equity in your home before the approval. Many home buyers will turn to a mortgage refinance though as one of the most popular options still.

Types Of Second Mortgages

You get quite some options to choose from for second mortgages. The number of options available varies from lender to lender. Majorly, there are two categories these mortgages fall into.

Home Equity Loan

You can avail of the total loan amount as a lump sum in a home equity loan. The borrower needs to pay a fixed amount as a premium for a fixed period. The monthly premium is a sum of both principal and interest, and the rate remains fixed over the term.

Home Equity Line Of Credit (HELOC)

You can avail of upfront loans using HELOC against a property you own. But unlike home equity loans, you can take loans as and when required instead of a lump sum. You only pay interest monthly on the withdrawn amount and can avail of more withdrawals within the draw period of about ten years. Once the draw period ends, you can repay the total amount you have borrowed in a lump sum. 

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Pros And Cons Of A Second Mortgage

Like any other loan, a second mortgage also has pros and cons.

Pros Of A Second Mortgage

Here are some advantages of availing of a second mortgage:

Higher Loan Amounts

Unlike any other loans, you are allowed to avail almost 80% to 90% of your house value in the case of second mortgages. Considering you have a good credit score and good payment history, your lender won’t hesitate to approve a higher loan amount.

Lower Interest Rates

Compared to credit card interest rates, the interest charged on second mortgages is less because collateral is involved. As such loans are usually considered secured loans, the interests are less.

No Fund Usage Limits

Second mortgages give you complete freedom to spend the money you need without being questioned about the reason. Whether you are paying your college debts or paying your wedding expenses, there’s no limit.

Doesn’t Consider Your Credit Score

Most loans won’t get approved unless you have a good credit score above 750. If you are taking second mortgages, you can get approval even with a bad credit score as long as you are a homeowner.

Cons Of A Second Mortgage

Here are some disadvantages of availing of a second mortgage:

Might Put Pressure On Your Budget

If you are taking a second mortgage, you’re taking the pressure of paying two monthly premiums — first, the original loan that you had taken on your house and secondly, the second mortgage.

Risk of Foreclosure

One of the significant hurdles regarding second mortgages is that you need to put your home on the line. If you cannot pay back the loan on time, your lender can occupy your home through foreclosure.

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Higher Loan Costs

In the case of second mortgages, the loan cost is usually a lot higher. You will probably have to pay for things like credit checks, appraisals, origination fees, and more. Besides, the closing costs can add up to thousands as well.

Interest Cost for the Loan

Though the second mortgage interest costs are comparatively lower than the credit card interest, they are much higher than the first loan’s interest rate.

When Should You Go For A Second Mortgage?

A second mortgage is not a usual go-to and definitely not for everyone. Here are some reasons why you might need to avail a second mortgage.

Paying Credit Card Debt

As credit card interest is comparatively higher, it makes sense for some people to avail of a second mortgage and pay back the complete debt. This is one way of converting your high-interest-bearing debt to low-interest demanding credit.

Invest In Home Equity

If you are planning to renovate your home, a second mortgage could prove to be the best option. It is essentially a way to invest the home’s equity in improving the value of the home itself. This increases the value of your property in the long run.

Revolving Credit Requirement

A second mortgage type HELOC helps you avail of credit whenever you need it within the draw period. It can be a much more convenient option, especially if you have home repairs or have some due bills to pay.

Unable To Get A Cash-Out Refinance

Compared to a second mortgage, a cash-out reliance has a lower interest rate. But the lenders might end up rejecting you for a refinance if you’re not a right fit. In that case, you can always avail of a second mortgage.

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Conclusion

Second mortgages aren’t as common as the first ones you take on your house, but they can be beneficial when you’re in dire need of money. Moreover, it makes sense to tap into your home’s equity to bail you out of a difficult financial situation. 

However, make sure you do not squander away the funds from a second mortgage on unnecessary luxuries. This can prove to be financially fatal and lead to bankruptcy. It is best to consult an expert before making any big decisions.

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