Maybe you’ve been in a similar situation. You took out a mortgage, and you’ve been steadily paying it out, and you suddenly start receiving invites from lenders asking you to take another mortgage. The money seems legitimate, the interest rates are competitive, and the promises can be quite tempting.
However, you might be wondering if it’s too risky. Before you get yourself tangled into another mortgage, it’s best that you’re well versed with everything a second mortgage entails. Here’s everything you need to know about taking a second mortgage.
Second Mortgage: What Is It?
Similar to the loan you took to purchase your home, a second mortgage is a loan that keeps your home as collateral. The mortgages are lined up according to the order in which you borrowed them. It’s known as a second mortgage because the loan you used to buy your home is predominantly the first one to be repaid. If the house is sold and you haven’t paid back the debt, you’ll have to pay the first mortgage before you give any money to the second or third mortgage (lender). In most cases, you can receive a second mortgage only after you’ve paid off a portion of your first loan. It’s a convenient method of obtaining urgent cash. However, a second mortgage is not the solution to all financial problems.
How Does It Work?
If you’ve already paid off a portion of your first loan, a second mortgage involves you applying for another loan with the same property as collateral. You’ll have to pay off your first mortgage before you start repaying the second one. This is why it’s difficult to qualify for second mortgages than conventional ones.
For instance, you have secured a first mortgage of $200,000 from lender A on your home, and you receive a second mortgage of $200,000 on the same property through lender B. if you’re unable to repay the loans and the home is sold for $380,000 then Lender A would receive the full amount and lender B will receive whatever is left. To qualify for a second mortgage, you’ll also need permission from your existing lender.
What’s Common Use?
A second mortgage can be used much like a guarantor loan, for example, your guarantor maybe in bank A, however, you don’t like bank A and prefer bank B, as long as there is sufficient usable equity within the guarantors property bank B will be happy to take a second mortgage/interest over that property. This is subject to the approval of bank A.
Advantages Of A Second Mortgage
A second mortgage does come with certain benefits. You may consider it for the following reasons:
- Tax Benefits
In certain cases, you might be eligible for a mortgage interest deduction on your second mortgage interest. However, it does come with numerous technicalities, so you must enquire about them with your taxpayer before you make deductions.
- Interest Rates
In comparison to other types of debts, a second mortgage has lower interests. Putting your home as collateral aids you because it minimizes the risk for your lender. Since the loans have low risk, lenders are willing to offer them with lower interest on second mortgages, unlike unsecured personal loans such as credit cards.
- Loan Amount
With a second mortgage, you can avail loans of larger amounts. Since your loan is secured by your home, you can get a much larger amount in comparison to not having collateral. How much you can receive depends on the lender, but you might be able to get a second mortgage up to 95% of the property value if it’s with the same bank.
Disadvantages Of A Second Mortgage
Along with advantages, second mortgages also have some drawbacks. If you avail them, you must use them wisely.
- Interests Costs
As with any loan, you’ll have to pay interests. Second mortgage interests are traditionally lesser than credit card interests but can be higher than your first loan rate.
- Loan Costs
Second, mortgages can be costly. You’ll have to pay for various costs such as origination fees, appraisals, credit checks, among others. Additionally, closing costs can easily incur you thousands of dollars. At times, you might even be promised a “no closing cost,” but you’ll still have to pay as there will be hidden costs.
- Risk Of Foreclosure
When it comes to second mortgages, putting your property on the line is one of the biggest risks. If you don’t make the payments, your home will be put through foreclosure, which can be very serious for you and your family. That’s why a second mortgage is not suitable for “current consumption costs.” It’s not advised to take a second mortgage loan for regular living expenses.
Why Do People Avail Second Mortgages?
Generally, people take out second mortgages for the following reasons:
- Many people access second mortgages to pay off existing debts such as medical, credit, or student debt or to pay off a portion of their first mortgage.
- Another common reason if for renovating their homes. If the property is renovated, the market value will go up, making it possible to get more equity. However, this method is only beneficial if the market value actually goes up. If it goes down, you’ll have a serious problem with no equity.
What’s The Eligibility Requirement For A Second Mortgage?
If your property is foreclosed, your first lender gets everything, and your second lender will have to take the leftovers. As a result, second mortgage lenders want to know certain things, such as:
- You don’t possess too much debt: As with your first mortgage, your second mortgage lender will also like to know that you have a stable income and that your debt is not too much. For this, they may want to review your bank statements, tax returns, and pay stubs.
- You own equity: Generally, your lender will have an appraiser inspect your property and calculate the equity. The appraiser examines the market value of your property to provide a precise number.
- You possess good credit: As with all loans, you need to prove your lender that you’re capable of making repayments. If you’re having trouble paying off the first mortgage, your application for a second mortgage will most likely be rejected.