When you need money, sometimes a second mortgage is the answer. Second mortgages, also known as home equity lines of credit (HELOCs) can be used to fund a variety of projects and goals. Let's review how they work along with some of the pros and cons.
What is a Second Mortgage?You may be familiar with a plan-vanilla mortgage, so what’s a second mortgage? It’s simply another mortgage on your home – a loan secured against the property. The term “second” indicates that the loan does not have priority on your home in case you default. Instead, your first mortgage (typically the loan used to purchase your home) has priority and that loan would be paid off before any funds go towards the second mortgage.
How to Use a Second Mortgage
Why would somebody risk their home with a second mortgage? These types of loans are appropriate for times when you need a lot of money. You may not have unlimited credit on your credit cards, and finding the cash just lying around is difficult.
Where is there a lot of equity or value? In your home, assuming you've paid off part of your home loan or your home's price has risen. Second mortgages may allow for bigger loans because the lender considers a loan against the home to be safer; the home serves as collateral.
Some common uses for second mortgages are:
- Home improvements
- Avoiding Private Mortgage Insurance (PMI)
- Debt Consolidation Programs
- Purchasing additional homes
- Creating a home equity line of credit (HELOC)
Some people use second mortgages for other purposes – and sometimes they are not wise uses of a home's equity. It can be tempting to tap a large source of money with a second mortgage, but you have to remember that you’re borrowing against your home. That said, if you really need money, a second mortgage is a fairly easy way to get it.
Disadvantages of Second Mortgages
The main disadvantage with second mortgages is that you are risking your home by using one. This is a serious risk: if you can’t pay the loan back, your lender can potentially foreclose and force you out of your property. Make sure that your intended use of funds is worth the risk you’re taking by using a second mortgage.
Another drawback is that second mortgages have slightly higher rates than senior mortgage rates. This is because the second mortgage won’t be paid until the first one is (in the event of a default). Because the loan is riskier than a plain-vanilla mortgage, it costs more. However, the rate might still be lower than alternative sources like credit cards and unsecured personal loans.
Finally, you may have to pay hefty second mortgage fees. There are a lot of hoops to jump through and services to pay for. Depending on how much you need and how long you’ll need it, a second mortgage may not work simply because of the fees.
Where to Find Second Mortgages
You can get a second mortgage from almost any lender. These are big-ticket loans that lenders love. A good start is to ask at an institution you’re already working with – like your existing bank or credit union. Or, you can try to get your second mortgage from the lender that has your primary mortgage. By keeping your business in one place, you might save a few bucks on fees.
Mortgage brokers and online lenders might also be a resource. Be sure to get quotes from several different sources (your bank, an online lender, and a mortgage broker) and compare offers before you borrow.
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