Second Mortgage: Why Get One And What You Should Know

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Heather Jones
Heather Jones
I'm Heather, an author passionate about home improvements. My writing is your guide to making homes better. Let's explore easy ways to enhance your living spaces, from small fixes to exciting projects. Join me on a journey of making your house a cozy and stylish haven.

It is common knowledge that when you make payments on your first mortgage, the amount of your loan capital decreases, which in return increases your home equity. You can then use your home equity to borrow money to finance a business, your children’s education, or any other expenses. This type of loan is called a second mortgage.  

What Is A Second Mortgage? 

With a second mortgage or a home equity loan, you can use your mortgaged property or home as collateral in taking out another loan. The interest rates for this loan are higher than the first mortgage. However, you can get a large sum of money at lower interest rates than other financing options that lend lump-sum amounts. 

Why Get A Second Mortgage? 

Most of the time, people want to consolidate their debts without using their first mortgage, making a second mortgage a great option. Thus, how does a home equity loan help consolidate your debts? 

If you want to save money on paying the principal amount and interest rates of your credit card debt, car loan, and other debts, taking out a home equity loan is a smart move. Once you receive the lump-sum payment for the second mortgage, you can pay all these existing loans, and simply make monthly payments for your second mortgage. Hence, a second mortgage is a great financial instrument for debt consolidation. 

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The same principle applies to refinancing your existing loans. You can use a second mortgage to pay off your personal or business loan early on. This means that you can refinance your loans at a lower rate. But of course, you’ll need to pay fees for booking a new loan and undergo the credit approval stage all over again. 

Here are the most common reasons homeowners take a home equity loan or a second mortgage: 

  • To avoid mortgage insurance  
  • Fund a start-up or existing business (such as buying equipment or sustaining the first few months of operations until sales are steady) 
  • Fund wedding expenses  
  • Fund a home improvement project 
  • Fund children’s college education  
  • Buy a new car (personal or business purposes) 
  • Buy a property (like a rental property for investment purposes or flipping a property
  • Cover emergency medical expenses  
  • Build a home equity line of credit (HELOC) 

What You Need To Know

A second mortgage is attractive to most people because it’s one of the most affordable financing options. However, before you get a second mortgage, read the following important points you need to remember: 

Second Mortgage

Difference Of Second Mortgage And HELOC 

Both home equity line of credit (HELOC) and second mortgage can provide you with a pool of funds accessible whenever you need money. They have lower interest rates than other financing options like personal loans. So, what’s the difference between the two? 

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With a second mortgage, you’ll receive a lump-sum payment upon approval of the loan and shoulder higher interest rates than the first mortgage, making this loan riskier. If the borrower runs default on the first mortgage, the second mortgage is also affected. Meanwhile, with HELOC, you can borrow a certain amount of cash as you need, and it may also be issued as a primary loan. 

Hence, while a second mortgage pays you in lump sum, a HELOC allows you to borrow money when you need it, but in specific amounts. 

Payments And Interest Rates 

A second mortgage has a fixed interest rate while HELOC has a variable interest rate, so monthly payments aren’t usually fixed. Typically, a second mortgage’s term is 5 to 30 years. Your lender will approve the length of the term based on several factors, such as your credit score and income sources. Regardless of the approved term, you’ll have stable, predictable monthly loan payments for your equity loan’s lifetime. 

Contract Terms  

A home equity loan or second mortgage contract includes the loan capital, the repayments made, the loan interest rate, and the repayment term. Homeowners can always use their home equity to get a loan, using another mortgage contract, in paying off their existing mortgage. 

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Second Mortgage Risk And Limitations 

Like any other loan type, a home equity loan comes with risks. You might lose your home due to foreclosure if you fail to make payments. Hence, it’s important to assess your financial capability before taking out a home equity loan. Choose the amount you can afford for a second mortgage to avoid default payment. 

Moreover, a home equity loan has extra costs included in the monthly payments. Some examples are appraisal, origination, and credit check fees, which makes it an expensive financing option for homeowners. That’s why you need to inquire about additional fees included in the loan amortization before getting a second mortgage.  

Increase Your Loan Amount 

The loan amount of a second mortgage depends on several factors, such as the combined loan-to-value ratio (CLTV) ratio, wherein you can loan 80% of your property’s appraised value. If you have a good credit history or you haven’t defaulted on your first mortgage payments and other credit products, the lender may increase your loan amount up to 90%. 

Therefore, before you get a second mortgage loan, you might want to improve your credit standing to strengthen your creditworthiness for a higher lump sum amount.  

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Recommended Use For Second Mortgage  

Knowing that you can use your home equity to get a second loan may give you numerous good reasons to take out a second mortgage. However, if you’re planning to spend the money to fund a grand vacation, then getting a home equity loan isn’t a good idea.  

You need to double-check the interest rates of your existing loans or debts before consolidating them. Remember that interest rates change and might become lower now than before. Speak with your financial institution or lenders to find out. 

Conclusion  

A second mortgage is a financial instrument wherein you can use your property to get a second loan. It’s a great financing option for home improvement, loan refinancing, debt consolidation, and funding your children’s college education.  

But of course, like any other type of loan, a second mortgage also has risks and limitations. That’s why you need to assess your needs and financial capability before taking out a home equity loan. This way, you won’t default on your payments and run the risk of losing your home.

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