Taking out a second mortgage allows you to borrow against the equity you’ve built up in your house. You can use the lump sum you receive from your second mortgage for whatever you wish. You can fund tangible projects like home improvements, pay off higher-interest debt such as credit cards or student loans, or finance a dream vacation. In short, second mortgages give you nearly limitless options regarding what you can do to take advantage of the money you’ve invested in your home.
There are plenty of situations where a second mortgage may make sense, but there are also a few alternatives that we’ll discuss as well, like refinancing. Although applying for a second mortgage may feel similar to the process involved with obtaining a primary mortgage, there are a few nuances that make a second mortgage application a bit more complex. Keep reading to learn the information that you need to prepare for applying for a second mortgage.
A second mortgage is a loan that you take out against the equity that you’ve already built in your home. To understand where second mortgages come into play, you have to understand the concept of equity. If you’ve been paying off your mortgage for a while, then you’ve built equity with each payment that you’ve made towards the principal loan amount. Unfortunately, the amount that you pay in interest each month doesn’t build equity.
If you own a house that is valued at $250,000 and you still owe $150,000 on the principal loan to your lender, then you’ve built $100,000 in equity in your home. For simplicity, the $100,00 is the part of your home that you own and the part you can borrow against when you get a second mortgage.
Second mortgages tend to be riskier for lenders because they will only be paid after your primary lender has been satisfied if you default. Consequently, second mortgages often have higher interest rates than primary mortgages.
There are two primary types of second mortgages: home equity loans and home equity lines of credit (HELOCs). Depending on your situation, as well as what you intend to use the money from your second mortgage for, you may prefer one over the other. Here’s a description of both types of loans.
When you secure a home equity loan, your lender will give you a lump sum of cash based on your equity. You can’t get 100% of your equity, but some lenders will loan you up to 90% of the equity that you have in your home. Home equity loans come with a fixed interest rate, so you’ll pay the same amount each month to repay your lender. Loan terms are between 5-30 years.
A Home Equity Line of Credit (HELOC) is a revolving line of credit that you’re granted based on your home’s equity. It gives you the flexibility to draw down your credit line based on your needs, repay, and borrow again. Unlike the home equity loan, you will not have a fixed monthly payment as the amount you borrow fluctuates based on how much of the line you use. Once the time frame of your HELOC is over, you must pay off your account, or the lender will come after your home.
HELOCs offer great flexibility, but you must exercise caution and discipline in using them.
You’ll need similar paperwork to apply for a primary mortgage loan, but with a few additions. The main second mortgage requirements are that you have equity in your home, and more of it increases your chances of securing a second mortgage. Lenders also want to know that you have good credit (at least a 620 credit score, often higher) and that you’re not carrying a lot of additional debt (a debt-to-income ratio below 43%).
When you apply, have the following pieces of information available:
A popular alternative to obtaining a second mortgage is refinancing your first mortgage. When you refinance your first mortgage, you essentially renegotiate the terms of your original home loan. If a lender refinances your original loan, they’ll use your home as collateral, but lenders providing a second mortgage don’t have that same security.
Homeowners interested in a second mortgage may also consider a cash-out refinance. This allows them to access a lump sum of cash based on their home equity in exchange for a new, higher principal loan balance. Instead of taking on a second monthly payment, homeowners can modify their current loan terms and monthly payment.
Consistent payments towards your second mortgage and good credit will also give homeowners the chance to secure second mortgage refinancing. That refinancing process may yield lower interest rates or the chance to consolidate multiple mortgage payments into a single loan.
There are three primary advantages to securing a second mortgage.
High loan amounts. With a second mortgage, you’re often allowed to borrow more money than other types of loans. This can be especially helpful if you’ve been making payments on your loan for a long time. Some lenders will allow you to borrow up to 90% of your home’s equity when you take out a second mortgage.
Lower interest rate than other types of credit. Since second mortgages are considered a kind of secured debt (your home ultimately serves as the collateral for the loan), you’ll pay a relatively low-interest rate. Some people choose to use the funds from their second mortgage to pay off credit cards or student loans that typically have higher interest rates. However, keep in mind that second mortgages often come with higher interest rates than primary mortgages because the secondary lender’s position is less secure than the primary lender’s place.
Use the funds however you want to. Unlike other loans, like auto loans or student loans, you’re not restricted in how you use the loan proceeds. Renovate your house, buy stocks, gold, or cryptocurrency, or do whatever you’d like.
Applying for a second mortgage is one option for accessing the equity that you have built-in your home. A home equity loan gives you access to a lump sum of cash, and a HELOC provides you with a line of credit, sometimes up to 90% of the value of the equity in your home. With those funds, people often pay off debt with higher interest rates, like credit cards or student loans, or pay for big purchases, like a home renovation.
Second mortgages are secured by your home, but secondary lenders will only be satisfied after the initial lender in the event of default. Depending on your situation, refinancing your primary mortgage, possibly with a cash-out refinance, might be preferable to a second mortgage, so be sure to consider all of your options. If you’re still wondering whether or not a second mortgage is the right decision for you, contact A and N Mortgage to speak with a knowledgeable mortgage consultant!
A and N Mortgage Services Inc, a mortgage banker in Chicago, IL provides you with high-quality home loan programs, including FHA home loans, tailored to fit your unique situation with some of the most competitive rates in the nation. Whether you are a first-time homebuyer, relocating to a new job, or buying an investment property, our expert team will help you use your new mortgage as a smart financial tool.
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