Second Mortgages Explained

So you’ve taken the big leap into homeownership and got a home loan. A mortgage is a type of loan that uses the property that was purchased as collateral. With a mortgage loan, borrowers are expected to pay monthly payments consisting of principal and interest portions. The more principal that is paid, the more equity a homeowner accrues throughout the loan term.

The equity that a homeowner accumulates can be regarded as their stake of claim in the property. At first, there is little to no equity in the home at the beginning of a mortgage prepayment schedule (depending on the down payment amount), but slowly, with every payment, a little more of the principal balance gets chipped away. This growing value is a borrower’s home equity and should be regarded as a huge financial accomplishment.

But besides having an increasing stake of ownership in the home you live in, home equity is a valuable resource to anyone with enough of it. Utilizing this valuable resource typically means using the equity as collateral for a large loan. Remember, it is not uncommon for people to have accumulated hundreds of thousands of dollars in home equity. After all, houses and the property they are on can be the most expensive purchases a person can make in their lifetime.

With the national average home price of $200,000, its easy to see that when homeowners accumulate equity, it can be quite a large value. So tapping into this resource, and using a home’s accumulated equity as collateral, is a feasible, and simply appealing financial strategy to most. Loans such as home equity lines of credit (HELOCs) and home equity loans (HELs) that use this value as collateral are referred to as “second mortgages”.

What is a Second Mortgage?

A second mortgage is a type of loan that uses a home or property as collateral, in the same way that the original mortgage used to purchase that home or property does. They are actually called “second” mortgages because the loan used to purchase the property is technically regarded as the “first” loan that uses the home as collateral. The distinction is important, but it is still extremely important to remember that second mortgages are every bit as important as first mortgages, considering they BOTH use the property as collateral against the amount borrowed. This means that failing to repay the second mortgage can also result in the loss of the home through foreclosure.

Typically, a second mortgage is taken out in one of two forms. One form of a second mortgage is a home equity loan, which is a loan distributed as a large lump sum of money based on the equity accumulated in the home. The other is the more popular home equity line of credit, which functions more like a credit card, with a revolving credit draw period based on the equity accumulated in the home.

Both home equity loans and home equity lines of credit are amazing financial tools a homeowner has at their disposal. These second mortgages can be used for a plethora of things, with little to no restrictions from the lenders that offer them. As such, they are utilized differently depending on the borrower’s needs or wants, and are available to almost any borrower with decent financial standings and enough home equity saved up.

Home Equity Loans (HEL)

Getting approved to borrow a large sum of money is no easy feat. Borrowers often have a myriad of hoops to jump through in order to qualify for even the smallest of loans. Often, however, there are situations that arise that call for large sums of money, that many of us simply don’t have laying around.

While some people get creative in finding a way out of such a situation, many are left scratching their heads as to what action to take next. Luckily, for the few who have some home equity accumulated, the answer is right in front of their eyes. Providing, of course, they are standing in front of their home.

For example, one of the most unexpected and gargantuan bills a person can receive is from a hospital or medical facility, following some unforeseen circumstance. By now, most people are aware that hospital bills can easily reach tens of thousands of dollars, and these institutions can be extremely aggressive in their collection methods. The question remains, how can such a large bill get paid off?

The answer? Take out a home equity loan. The equity in your home can potentially be worth hundreds of thousands of dollars depending on how long you’ve been paying your mortgage and is the perfect collateral for a loan that needs to be rather large in value.

Home equity loans are distributed as large lump sums of money, so they are perfect for paying off large bills, consolidating debt, making large one-time purchases, or even used as a down payment when eligible.

The best part is that since you are using a pre-existing source of value as collateral, Home equity loans are fairly easy to qualify for. That means getting a loan for a huge sum of money relatively faster than through any other means. They even have fixed interest rates that can be lower than the average market rate at the time of borrowing.

Home Equity Lines of Credit (HELOC)

If you live long enough, it's only normal to wonder about ways to extend your resources (and by resources, we mean money). Sure, a second job or even a marketable hobby can get you the extra income you desire, but let's face it, not everyone has the time to work full time, and jump into another job when not working that full-time position. On top of that, sometimes all you really need is a temporary boost in cash flow to get you through a particular project or scenario.

Credit cards may be able to do the trick, but these are notorious for having spending limits that are all too easy to reach. Suppose you need more than your credit card allows you to spend, but you aren't sure of an exact figure of how much money you actually need. A home equity line of credit (HELOC) is the perfect solution for this type of situation.

Home equity lines of credit are not unlike credit cards, in that they are both revolving lines of credit. The difference, however, is that the basis for the HELOC credit line is the equity of your home. Again, this could mean a rather large pool of money to draw from, thus eliminating those pesky spending limits associated with credit cards.

With a HELOC, in most cases, a borrower is given a card to use in order to draw money from the credit line. There is no limit to how much money a borrower is able to draw (within the total amount available), however, some HELOCs do have a minimum amount in place. The absolute best part is that borrowers are only required to pay interest on the amount that you draw and use, not the total amount available.

Home equity lines of credit do have some limitations, though. For starters, the money is only available to be drawn during predetermined draw periods, so some care should be taken to use the funding wisely when available. In addition, the line of credit does not stay open forever, with most HELOCs lasting about 10 years in term length.

Still, there is no better way to fund large projects such as costly home renovation or even starting up a small business. Interest rates on home equity lines of credit are typically variable, but since you only need to pay interest on what you actually use, the benefits far outweigh the cost. Furthermore, the limit is replenishable once paid off, so technically, it can be utilized near infinitely as long as you own the home, accrue equity, and are able to pay the HELOC off each time.

Benefits of Second Mortgages

It is not hard to understand just how useful a second mortgage can be for a borrower in need of some extra cash. Utilizing home equity as collateral for a loan not only greatly increases the amount of money one may be able to borrow, but also makes it easier to qualify for that much of a substantial loan. Depending on what they are to be used for, home equity lines of credit and home equity loans are quite powerful financial tools for any homeowner to use in a pinch.

Some benefits of second mortgages include:

Manageable Interest Rates

One of the most important things to consider with any loan is the interest rate that you have to contend with when repaying the debt. Interest is the cost of a loan, and shopping around for a great interest rate is recommended of any potential borrower, no matter the situation. Luckily, the interest rates on second mortgages are pretty straightforward.

For home equity loans, borrowers are usually given a fixed interest rate. This rate remains stable throughout the entire loan term, so repayment of the loan can be done with predictable, unchanging monthly payments. Usually, the rate is highly competitive with the current market rates, so you shouldn’t have to worry about spending too much for your loan.

With home equity lines of credit, borrowers can typically expect a variable interest rate to contend with. However, this isn’t as problematic as one would assume, since you can only draw money during specific, predetermined times anyway. In addition, you are only expected to pay interest on the amount of money that you use, not the entire pool available to you.

Loan Amount

Trying to borrow $80,000 with just a good credit score and a couple of W2’s might get you laughed out of even the most respectable lending institutions. The reason people are approved to borrow large sums of money to buy cars or homes is because the thing that they are purchasing is the collateral for the loan. In other words, if you don’t pay your car note, the bank will seize your car. Likewise, if you don’t pay your mortgage, a foreclosure notice will be in your mailbox sooner than you would like to believe.

What makes second mortgages so great is that the value of your home that you have already paid for is the perfect collateral to use if you need a large loan. After all, it isn’t really of much use to anyone until the home is being sold, anyway. Make no mistake, your home is more than just a shelter from the outside world, it is a strong financial asset that, if used properly, can yield awesome results.

Home equity is accrued with every monthly mortgage payment, as well as the general flow of the market. Often times, neighborhoods go through dramatic increases in home values, which can make the value of your home worth even more than you originally purchased it for. This added value is great when you decide to sell your home, but it can be put to use long before you reach that decision -- through a second mortgage.

It isn’t crazy to have tens, if not hundreds of thousands of dollars accrued in home equity, depending on how long you've been paying your mortgage, and where your home is located. Putting this value up as collateral allows lenders to loan you amounts of up to 80% of this value. Needless to say, that’s a lot of cash.

Drawbacks of Second Mortgages

While it may be hard to think of anything that could detract from the sheer benefits of second mortgages, no loan is perfect.It always pays to weigh out the benefits with the drawbacks of any given loan in order to see if it is worth the trouble. Second mortgages are no different.

Drawbacks to second mortgages include:

Risk

Borrowing against the equity in your home allows for huge loans coupled with ease of access. While this sounds like the best possible thing to ever happen to anyone, it is also a huge risk to consider. Remember, just like a “first” mortgage, your home is the collateral for a second mortgage.

All that to say, if you fail to repay your second mortgage, your home can be seized legally. This is the most important thing to remember when considering any home equity loan or HELOC. Being able to use your home value as collateral is beneficial in plenty of ways, but collateral is still collateral.

Taking out a second mortgage on your home means literally putting your house on the line should anything happen and you fail to repay the debt obligation. It is tragic, but there are homeowners who had to go through the foreclosure process because of negligence with second mortgages. At any cost, both first and second mortgages are loans that require the utmost responsibility in paying back.

That is why second mortgages like HELOCs or home equity loans should only ever be considered for important or unavoidable expenses, even though there are technically no restrictions on how they can be used. Always exercise caution and restraint when handling a second mortgage, you never know what will happen in the future, and you must be sure whatever you borrow can be paid back.

Cost

It may seem odd to talk about cost when speaking about receiving a loan for a large sum of money, but loans are never free, and some are far more expensive than others. Second mortgages may not be the worst when it comes to interest rates, but they can still cost a pretty penny over time, considering they are typically not the only bills a borrower has to pay.

The interest rates on home equity loans are fixed, and much lower than most credit options, but they tend to typically be higher than the interest rate on your first mortgage. HELOCs are a different beast entirely, as they have variable interest rates that are at the whim of the volatility of the benchmark rate that the interest is based on. Needless to say, drawing money during a high-interest period could be a costly choice.

Still, interest rates on second mortgages aren't the real costly part. In truth, these loans have some pretty large closing costs to contend with. Since we are talking about a second mortgage, things like credit checks, appraisals, origination fees, and more are to be expected, and they all come at a price. Closing costs for second mortgages can be up in the thousands, and even the so-called “no-cost” loans have fees that you simply aren't made aware of.

Uses for a Second Mortgage

Second mortgages are definitely something to think about at length before diving in head first. While there are many benefits to getting a HELOC or home equity loan, there are also some dangerous risks involved. Still, what good is knowing the benefits and risks without knowing how you can utilize a second mortgage?

To begin with, there are very few limitations (if any) on what the proceeds from a second mortgage can be used for. That's right, the borrower has the freedom to use that money as they see fit, so long as they can pay it back. The possibilities are endless, but it goes without saying that with your home on the line, however you decide to tap into your home equity, it should always be done responsibly.

Since home equity loans and home equity lines of credit function differently, they should be utilized in different ways to maximize their usefulness.

Again, these are some of the more responsible uses for second mortgages. That doesn’t mean you can’t go ahead and buy that new 75 inch curved 4k smart tv that you’ve been eyeing for the last month, these are just suggested uses. The reality is that it is up to you, the borrower to decide what to do with the funding you get. Just be sure to remember what is at stake.

Second Mortgages: In Review

No matter which way you slice it, a second mortgage is a powerful resource for any homeowner with enough home equity. Second mortgages are not only easier to qualify for than an unsecured loan, but you can borrow up to 80% of the equity in your home. That value can range well into and sometimes past the tens of thousands range.

Second mortgages should be carefully considered though, as your home is on the line as collateral in the even you cannot pay back what you have borrowed. Still, properly utilizing a home equity loan to cover some large emergency expense or using a HELOC to fund necessary home repairs is a no-brainer. A little responsibility goes a long way in this case.

Second mortgages have the power to change a borrower’s fortune or leave them in ruin depending on how they are used and repaid. If you’re curious about what a second mortgage could do for you, or simply want to get advice or quotes on a home equity loan or HELOC, no need to worry, just call a home.loans mortgage specialist today for a risk-free consultation!