Have you ever considered getting a second mortgage? If so, it’s important to answer the following questions:
- What is a second mortgage?
- What are the benefits of getting a second mortgage?
- What are the drawbacks of getting a second mortgage?
- Why do people obtain a second mortgage?
In this article, we’ll answer all of these questions — and more.
What Is a Second Mortgage?
Contrary to popular belief, a second mortgage isn’t the same type of loan you used to purchase your home.
This loan simply uses your home as collateral, should you fail to make regular payments. The term “second mortgage” comes from the idea that your purchase loan is the first loan secured by your home.
This loan is the second.
How Does a Second Mortgage Work?
Your second mortgage is based on the equity of your home. Equity is the market value of your property after loan balances are taken into account.
You can calculate this number yourself by:
- Subtracting the amount owed on your loan from the market value of your home.
- Taking that number and subtracting from one. This result is your equity percentage.
- Multiplying that number by your home value. This is how much your second mortgage could be worth.
Your equity can be positively altered when you make monthly payments on your mortgage and reduce your loan balance, when your home gains value thanks to a strong real estate market, or when you make improvements to your home that increase its worth.
Your equity can be negatively altered when your home loses value, or when you borrow against your home. This means your equity will decrease once you get obtain a second mortgage.
Reasons to Get a Second Mortgage?
There are several reasons homeowners consider getting a second mortgage, but nearly all of them involve funding other endeavors. For example:
- Home improvement. Homeowners often obtain a second mortgage in the hopes of improving their home, repaying the loan, and selling for a higher market value. This is perhaps the most efficient use of a second mortgage. If you use only the amount you need for renovation, and you choose renovation projects that will increase the value of your home by at least as much as you invested, you’ll make money by utilizing the equity of your home.
- Debt consolidation. Because second mortgages often have a lower rate than student loan lenders, credit card companies, and automobile lenders, homeowners often take advantage of a second loan to pay these balances, thus consolidating debt. This could lower your monthly debt payment and simplify the repayment process. However, it’s important to be cautious. You might be trading unsecured debt for a loan that could cost your home.
- Higher education. Some homeowners may prefer a second mortgage to spiraling student loan debt. Before making this decision, exhaust your other options. Can you obtain federal student aid? While second mortgages are known for low interest rates, federal student loans are nearly always better.
- Vacation and recreation. Unfortunately, a large number of homeowners are interested in second mortgages simply because they want more spending money. This is a categorically poor decision, and should not be made lightly. If you feel a second mortgage can successfully fund vacation and recreational investments, speak to a professional before signing your home away. There may be more efficient options.
The Advantages and Disadvantages of Getting a Second Mortgage
There are both advantages and disadvantages to getting a second mortgage.
Some of the advantages can include:
- Lower interest rates. Second mortgages are well-known for having low interest rates when compared with other types of debt. These low rates correlate with low-risk, since your home serves as collateral for your lender.
- More tax deductions. In some cases, you can claim an added deduction for interest paid on your second mortgage. However, making this claim is a complex process and should only be filed with the aid of a tax professional.
- High loan amount. Because a second mortgage is based on the equity of your home, you could be eligible for 80% of the value of your home, depending on the lender you choose.
Some of the disadvantages can include:
- Risk of losing your home. This is the biggest risk associated with obtaining a second mortgage. You are literally putting your home on the line. If you stop making payments, your lender will be able to start the foreclosure process, which can lead to serious financial problems for yourself and your family.
- The added expense. Even with low interest rates, a second mortgage can be expensive. You’re agreeing to take on hundreds of dollars of debt each month. You’ll also need to pay for credit checks, appraisals, origination fees, and other closing costs.
- Paying interest. While second mortgage interest rates are often lower than credit card rates, they are usually a bit higher than your initial mortgage. In terms of your credit score and saving money, paying any amount of interest is a drawback.
Does Embrace Do Second Mortgages?
While we don’t offer second mortgages, we are more than happy to answer your questions and help determine if a different mortgage product may be better for you — like a cash-out refinance.
Contact a Mortgage Professional to Learn More
Whether you want to purchase a new home or refinance an existing mortgage, we’re here for you. We have thirty years of experience in the mortgage business, and are one of the fastest-growing lenders in the country. Contact one of our loan officers today learn more!