Everything You Need to Know About Second Mortgages
As a homeowner, and as you pay off your mortgage, you build equity in your home. This is very valuable and can provide many financial advantages, like accessing cash at a low rate through a second mortgage. Before going this route, though, it's important to understand how the process works.
What is a Second Mortgage?
A second mortgage is any loan where the borrower uses a home he or she already owns as collateral. When you take out your initial mortgage loan, your home functions as collateral on the loan and a second mortgage is similar. However, the loan is secured by home equity that the borrower has built up through the purchase or paying down the original mortgage over time.
The amount of equity you have is your home's value minus what you owe on your mortgage. Every time you make a payment on the purchase loan of your home, your equity increases. When you take out a second mortgage, your equity goes down. However, you have access to the funds, usually at a low rate, in return. You'll make payments on your second mortgage until it is paid off just like you've made payments on your home purchase loan.
Types of Second Mortgages
When it comes to second mortgages, there are two primary types — lump-sum loans and lines of credit. It's important to understand the difference between these options to determine which is best for your needs. A lump-sum second mortgage consists of a one-time loan payment. You receive the entire amount up front to do with as you please. You'll then start making installment payments on the loan until it is paid off. When you take out a line of credit for your second mortgage, you'll have credit available that you can use. However, there will be a limit as this line of credit functions like a credit card. When you repay the money you've spent, you'll have this credit available again.
When a Second Mortgage Makes Sense
Leveraging the equity in your home can be an excellent way to access funds at a low rate when you need to upgrade, pay for school, to pay off high-interest debt or almost any other large expense. Second mortgages typically offer much lower rates and more favorable terms than a personal loan or credit card.
In addition to enjoying lower interest rates, second mortgages also generally offer higher loan amounts. Again, the lender is dealing with less risk because the loan is secured by home equity. Therefore, lenders tend to offer loan amounts approaching the value of the borrower's home equity.
When you take out a second mortgage, you're putting your home on the line. If you fail to keep up with payments, you risk losing your property. A second mortgage also adds to your total debt. You need to make sure that you're managing your finances carefully so that your debt doesn't get out of hand.