Despite the challenges and responsibilities of owning a home, there are clear advantages to buying your own place. Owning a home contributes to your net worth, and as you pay down the home loan balance, the property earns equity — the difference between your property’s value and what you owe. The more equity in your house, the more options you have, such as applying for a second mortgage.
A second mortgage is a loan secured by your home’s equity. If you need additional cash and you have ample equity, a second home mortgage is worth consideration.
There are two types of second mortgages: A home equity loan and a home equity line of credit. Both options use your equity as collateral. A home equity loan is similar to a first mortgage, in which you receive a fixed or adjustable rate loan with a 15-, 20- or 30-year term. A home equity line of credit is a revolving credit line — similar to a credit card — and typically features a variable interest rate. Once your lender opens the line of credit, you can withdraw funds on an as-needed basis.
The proceeds from a second home mortgage can be used for a variety of purposes, such as college tuition, debt consolidation, business startup, wedding expenses or home improvements.
A second mortgage is only for borrowers who have at least 20 percent equity in their homes. But even with equity, there are limits to what you can borrow. As a rule, you can borrow up to 80 percent of your home’s value, minus what you owe on your first mortgage. Let’s say your home is valued at $200,000, but you have an outstanding balance of $80,000. In this case, your home’s equity equals $120,000, thus you’re eligible for a second mortgage up to $40,000.
Note that it takes more than equity to qualify for a second mortgage. Approvals are subject to an acceptable credit score and payment history. And since a second mortgage creates a new monthly bill, lenders will review your existing debt and income to determine if you can afford any additional financial obligations.
Because a second home mortgage is additional debt on top of a first home loan, there is more risk for the lender to provide one. That’s why second home mortgage rates tend to be a bit higher than traditional mortgage rates. However, don’t let this difference dissuade you from pursuing a second mortgage — second home mortgage rates are usually only about a quarter of a percent higher.
A second mortgage can provide much needed cash and the interest paid on this loan is typically tax deductible. However, these types of loans are risky. Because your equity serves as collateral for the loan, your second mortgage lender can initiate a foreclosure if you stop paying on the loan. What’s more, second home mortgage rates are normally higher than first mortgage rates.
Before applying for a home equity loan or a home equity line of credit, carefully weigh the benefits and the drawbacks. Consider whether you can financial manage another monthly payment. A second mortgage isn’t free money and payment problems can trigger negative remarks on your credit report and a lower credit score.
If you decide to apply for a second mortgage or a refinance second mortgage, shop around and compare second home mortgage rates to help lower your interest rate and minimize your payments.