If you need a large sum of cash but don’t want to pay the hefty interest rates attached to credit cards and other types of loans, consider applying for a second mortgage. Find out exactly what a second mortgage is, how they work, the different types and what you need to apply for one.
Understanding Second Mortgages
If you’re a homeowner in need of a large sum of money, you have a variety of options to receive those funds. You could use a credit card, but they have interest rates that can reach over 20%. You can secure a loan through your bank or another lender, but these loans can be a hassle to obtain, as you may have to jump through a variety of financial hoops to try and meet the criteria to obtain the loan. Many people can’t meet the criteria required. If you find yourself in this situation, then consider a second mortgage.
What is a Second Mortgage?
If you’ve had problems in the past trying to secure a loan due to bad credit, bankruptcy or not meeting other requirements with lenders; a second mortgage may be the route to take. A second mortgage is a type of loan that lets you borrow funds against the value of your home. A person’s home is typically the biggest asset they have, and over time, that asset becomes more valuable.
Second mortgages, which can come in the form of a home equity line of credit (HELOCs) or a home equity loan, are a way to use your home as an asset. You can use the equity you’ve built in your home to fund your financial needs, whatever those needs may be.
How does Equity Work?
A second mortgage uses the equity found in your home. Equity is the market price of your home minus any loan balances. Your equity can increase over time if the property value increases or if you pay down the balance on the mortgage loan. With a second mortgage you can then tap into the equity in your home without selling it. Equity can increase or decrease, but generally, it increases over time and often changes in a few different ways:
- Making your monthly payments on your loan reduces your loan balance. This, in turn, increases your equity.
- If your home gains value due to a strong housing market or because of home improvements you make, your equity will increase.
- You can lose equity if your home loses value or you borrow money against your home.
Types of Second Mortgages
Although they can come in various forms; the two most standard types of second mortgage loans are a lump sum and a line of credit.
Lump-sum
A very popular form of second mortgage is a one-time home equity loan that comes in one large chunk. You will repay this loan gradually over time, typically with fixed monthly payments. Each payment you make will consist of a portion of the loan, as well as interest costs.
HELOC
A home equity line of credit is another favoured choice for a second mortgage loan. Like a line of credit, this is a pool of money that you can draw from as you need to. Your lender will set a maximum borrowing limit on the HELOC based on the equity available to you. You can borrow and repay over and over like with a credit card, and you only pay interest on the money you have taken out.
While traditional banks and B-lending level lenders offer lump-sum and HELOC second mortgages, these types of loans are not always available to everyone. It’s important to know that there are reputable lenders out there who work specifically with clients who(se):
Borrowers in these situations do have options and can find a second mortgage.
Why do Homeowners Take Out a Second Mortgage?
There are many reasons that homeowners use the equity in their home to take out a second mortgage. A few of the most common reasons include:
Accessing large amounts of money
Since the loan is secured using your home as collateral, you can borrow a much larger sum of money than you would possibly be able to get from other borrowing methods. Depending on your lender, you may be able to access up to 85% of your home’s value, even if you have poor credit, are self employed, or are otherwise considered a high risk borrower.
Lower interest rates
Second mortgages have much lower interest rates attached to them than other types of loans. Again, due to your home being used to secure the loan, lenders feel the loan is less risky, which in turn, means you pay a lower interest rate.
Paying off debt
Consolidating debt is a common reason for homeowners to take out a second mortgage. Second mortgages carry lower interest rates than credit cards and other loans. It’s financially wise to use the money from a second mortgage to pay off debts that carry higher interest rates, which can save you money annually.
Home renovations
Repairs and home renovations are expensive, and many homeowners use the funds from a second mortgage to pay for them. This offers a few benefits, as you increase your property value and equity as well as avoid putting large sums of money on your credit cards to pay for necessary home renovations.
Tax benefits
Depending on the tax laws in your area, you may be able to take a mortgage interest deduction for the interest paid on a second mortgage. There are a ton of technicalities involved in this process, so ask a tax expert before moving forward.
Applying for a Second Mortgage
Before you apply for a second mortgage, it’s important to:
- Contemplate and understand all the risks involved in receiving a second mortgage.
- Ask yourself why you want a second mortgage and what you will do with the funds if approved for one.
- Create a realistic budget to ensure you can cover the monthly mortgage payments on your second mortgage.
- Figure out what kind of second mortgage you want.
- Know your credit score and find a lender who will work with you if your credit score is low. There are many reputable lenders who specialize in helping high-risk borrowers.
- Calculate how much equity is in your home.
- Meet with a potential lender after you have acquired all integral documentation and attend that meeting prepared with a list of questions.
Find the Right Professional for Your Situation
As with any financial endeavour, you need to be aware of all the risks involved in taking out a second mortgage. This process involves a large sum of money and your home. It’s not to be taken lightly. So, make sure you talk to a professional before jumping in. Do your research first and feel confident asking questions to ensure that the lender is aware of your financial situation and willing and able to help you qualify for a second mortgage.