The Process Of Getting A Second Mortgage
For most families, a home is their most valuable asset. However, getting that value as cash means taking out a second mortgage.
A second mortgage is a type of loan given to existing homeowners. Second mortgages have many benefits, including lower interest rates and generous borrowing limits. In this article, we explore what are second mortgages, how they work and how to apply for one.
How Does a Second Mortgage Work?
A second mortgage can get you a loan by using your existing home as collateral. It’s called second mortgage because it is “second” to the original loan that first purchased the home. A second mortgage is paid as a one-time lump sum of money that homeowners can use for whatever they want. Most borrowers request second mortgages because the interest rates or repayment schedule is more favorable than refinancing.
Second mortgages are often paid out as Home Equity Lines of Credit or “HELOC.” In this case, the bank approves a pool of money the homeowner can draw from whenever they need it. A HELOC can be used and re-paid multiple times. This makes home equity lines of credit very useful for families who are looking for a safeguard against emergencies. A potential downside is that home equity lines of credit come with adjustable interest rates.
Second mortgages affect the equity of a home, which equals their market value after discounting any remaining loan balances. The equity of a home fluctuates constantly according to local market prices and other financial factors, although most houses grow in value over time. Because second mortgages are subordinate to an original mortgage loan, they often come with higher interest rates to offset the additional risk. If a default happens, proceeds from liquidation will be given to the first mortgage lender until it is paid off. Any extra money is then awarded to whoever approved the second mortgage.
Benefits and Disadvantages of Second Mortgages
Second mortgages have superior benefits when compared to other types of debt. The amount of money that can be borrowed through a second mortgage is significant. In general, homeowners have access to as much as 80 percent of their home’s value. However, that number includes any outstanding balance from the first mortgage. For example, if a family owns a $200,000 house and still owes $100,000 on their first mortgage, the maximum amount available to borrow will be $60,000.
The benefits of second mortgages come with some significant tradeoffs. For many families, the main disadvantage of a second mortgage is that it raises risk of foreclosure. To obtain a second mortgage, homeowners have to put their houses as collateral. If their financial condition deteriorates and they are unable to pay, the bank can force foreclosure. Because of this, second mortgages are rarely used to finance recurrent expenses. Unsecured personal loans, although with higher interest rates, are a less risky option.
Another downside of second mortgages is the amount of money spent during the application process. Closing costs such as credit checks, home inspection, appraisals and origination fees can add up to several thousand dollars. Some financial institutions promise their customers no closing costs, but some expenses still have to be covered by homeowners.
How to Get a Second Mortgage
There are several things to consider before applying for a second mortgage. Homeowners should calculate the risk they are taking, and what impact a second mortgage will have on monthly bills. Preparing a budget is an effective way to visualize how affordable these payments will be. In general, homeowners should spend no more than a third of their income in housing costs, including mortgage payments, utilities, property taxes and insurance.
The second step is to determine how the money will be spent, and choose what kind of home equity loan better adapts to those needs. Home equity lines of credit (HELOCs) are better for families who anticipate future spending and want to be prepared. HELOCs work like credit cards, as homeowners only have to pay interest on what they borrow. In contrast, home equity loans are better if the family has a precise spending plan, such as to perform home improvements or purchase a new vehicle.
Once the market value and home equity have been determined, homeowners can contact their preferred financial institution to request a second mortgage. Families with a good financial history will often get their bank to approve a home equity loan without much trouble. However, exploring the market for better rates is always a good idea. Most customers stick to their banks, which gives them the power to offer less competitive rates overall.
Submitting the loan application is a very straightforward process. The financial institution will request documentation and offer several options to choose from. Homeowners can choose how much they want to borrow, if they want adjustable or fixed interest rates, and other repayment conditions. Once the application is approved, the bank will either deposit the money or create a home equity line of credit. If needed, homeowners can choose to add a co-borrower to their mortgage application to improve their chances and obtain more generous terms.
Millions of homeowners apply for a second mortgage every year. Some do to improve their homes while others invest the money in education, a business or medical emergency. Although asking for a second mortgage may seem like an easy solution to a problem, homeowners should always weight the risk of putting their homes on the line.