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How Do Second Mortgages Work?

Many homeowners are not aware of the fact that they can take a second loan on their homes. The first loan, known as the first or the primary mortgage, is usually taken while buying the house. The second loan against the same property, while your primary mortgage is still not fully paid, is known as the second mortgage.

Having a good understanding of how do second mortgages work can prove to be very useful when you need quick funds for an emergency, an investment, a child’s tuition, to pay off high interest consumer debt, or even home renovations.

KEY ASPECTS OF SECOND MORTGAGES

A second mortgage is subordinate to the first mortgage, which means that in the event of default, the first mortgage will get priority in terms of repayment. Only after the first mortgage has been completely repaid from the sale proceeds will the 2nd mortgage lender will be able to recover the loan.

A mortgage is always taken out against the equity in your home, and second mortgages are no exception. The loan amount that the second mortgage lender will offer you will depend on the equity built up in your home.

Interest rates on a second mortgage are higher than those charged on the first one. This is because the second mortgage lender is taking a higher risk, as he gets second priority in case of default. That said, working with a mortgage professional can help you reduce these rates and obtain the right product for your financial situation.

TYPES OF SECOND MORTGAGES

There are two primary types of second mortgage loans: a home equity line of credit (HELOC) and a home equity loan. A HELOC is similar in structure to getting a consumer line of credit. Except a HELOC allows you to borrow a certain amount against the equity of your home.

Second mortgages allow you to access up to 80% of the equity you have in your property, and 85% in major cities. Consider that you own a property valued at $500,000, and your first mortgage is for $325,000. In this case you’d be able to access $75,000 upon obtaining a second mortgage if approved.

A home equity loan will provide you with a lump sum of money using your home as collateral. With the right mortgage professional, you can obtain a home equity loan through a lender in the same way you got your primary mortgage. The interest rate is fixed, which allows you to plan on consistent payments, but the interest rate is almost always higher than the interest rate of a primary mortgage.

Many people choose a home equity loan over a HELOC because it allows you to receive lump sum of cash that you can use immediately.

CHOOSING A SECOND MORTGAGE FOR THE RIGHT REASONS

To be sure, applying for a second mortgage has distinct benefits. You gain access to the equity in your home for a variety of potential expenditures.

The most common use for second mortgages is getting rid of high-interest consumer debt, like credit card debt. This of the burden that this would take off your shoulders not having any more credit card debt. With the average credit card interest rate being 15%, you could save a lot of money by leveraging a second mortgage.

The second most common usage for second mortgages is to finance home renovations. Home improvements add value to the house and guarantee a better price should you decide to sell the house in future.

This means that you are using the money from an asset (your home) to increase the value of that asset itself. Those with mounting credit card debt can also take out a second mortgage for debt consolidation purposes to make repayments more affordable and manageable.

Other uses for second mortgages include:

  • Rainy day fund
  • Tuition for a child
  • Business or real estate investments
  • Medical expenses

THE RISKS INVOLVED

A discussion on how do second mortgages work is incomplete without mentioning the risks involved. Although such a mortgage can prove to be very useful when you need a lot of cash quickly, don’t forget that like any other loan taken against an asset, it puts that asset at risk.

If you are unable to keep up with your payments, the lender will have to resort to foreclosure and you could end up losing your home. So, make sure that you fully understand your repayment capability before you take out a second mortgage.

IS A SECOND MORTGAGE RIGHT FOR YOU?

There are many different factors that might contribute to your interest in getting a second mortgage, and it’s important that you carefully consider each before you make your final decision.

The first thing you should think about is your ability to pay. You will have to consistently pay both your second mortgage and your primary mortgage—and these payments can quickly become overwhelming.

You should also think about whether there is a better way for you to fund the project or need that you have. If you want to finance a home renovation, for example, consider holding off until you can save up enough to cover the costs. Even though you may have to delay your planned renovation, you won’t have to take on the burden of a second mortgage and risk losing your home if you were to default on payments.

This is why speaking with a mortgage professional is important when considering whether or not a second mortgage is right for you.

Many people find themselves in a major financial hole after getting a second mortgage to pay off debt because they didn’t address the issues that caused them to wind up in debt in the first place. Before you apply for a second mortgage loan, take some time to reduce your debt and implement responsible spending habits and budgeting.

Once you understand how do second mortgages work, you can initiate the process by applying for a second mortgage through the lender of your current mortgage, or a broker who can work with you to find the best solution to fit your financial situation. There could be some difference in interest rates and loan terms from one lender to another, and you need to evaluate offers from different lenders carefully before choosing one.

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