When you are first purchasing a home, you likely need to secure a loan, known as a “Mortgage.” That loan covers all of the costs of the house beyond the down payment, focusing solely on the price of the house upon purchase.
But homes are not valued by their purchase price. Once the transaction is complete, homes are valued by appraisal, and appraisals provide you with a number known as equity – or the value of your home minus the money owed to your mortgage.
This equity belongs to you, and it is the portion of the property that represents your investment. If you sold the property at its market value, you would receive the equity of your home in cash for you to place in your bank account.
Knowing that this value exists allows banks to recognize that you have the collateral necessary to borrow money. And so banks (and lending institutions) offer homeowners with equity a chance to take what is known as a “Second Mortgage” on their property, in order to have cash on hand for whatever items they need to finance.
Defining Second Mortgages
Second mortgages are secured loans taken against your home’s equity. They are subordinate to your first mortgage, which means that if you default on your home and your home is put up for auction, the amount it sells for at auction first goes to pay off your primary mortgage before covering any of the costs of your second mortgage.
What are Second Mortgages Used For?
People generally used second mortgages for unforeseen or necessary large expenses. Because they represent a sudden, large loan taken against your equity, though they are useful they are not to be used lightly. Examples of expenses paid for by second mortgages include:
- Medical bills
- Tuition
- New cars
- Home repair/renovation
- Business ventures
It is also not uncommon for those that are laid off to take second mortgages in order to pay their daily bills while they look for a new job. For all of these uses, second mortgages can be very valuable. The equity you have in your home is already yours, and so a loan against your home is as though you are taking a loan against your future income.
What are the Risks With Second Mortgages?
The most glaring risk with taking a second mortgage is that you have yet another loan payment to make where defaulting could cause you to lose your house. A mortgage loan on a home is worthwhile, because otherwise the home could not be purchased. But all other optional loans that use your home as collateral should be avoided unless necessary.
In addition, second mortgage rates are not going to be as low as primary mortgages, simply because – though your home is being used as collateral – it does not guarantee that you will be able to cover the costs of the loan. Once again, your primary mortgage gets first priority over your home in the event of foreclosure, and if the value of selling your home does not cover the costs of the 2nd loan, you will continue to owe them money, which means they carry greater risk.
Second mortgages may also be quite expensive. The number of fees associated with simply taking put one of these loans may considerably devalue the benefit to using them. They are also one of the main targets of unscrupulous lenders. Also, like any loan, they can be brutal on your credit score. Second mortgages are still loans, and any additional loan can make your credit score plummet.
Is a Second Mortgage Right For You?
Despite these risks, second mortgages still have a great deal of value. They are lower interest loans than unsecured loans. They can provide you with a greater loan amount depending on the value of your equity, which may be beneficial for large expenses. And they allow you to receive a loan fairly quickly which may easily help fill your emergency needs. Provided there are no better sources for loans available and you are confident that you will have the means to pay back the loan over time, a second mortgage is a great way to get a large sum of instant money when you need it.
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Second mortgages are risky loans. On the one hand they provide you with ample financing for almost any purchase, whether you need money to pay for tuition, cover the costs of a serious car accident, or simply take a much needed long vacation. But like all loans, they are not without risk – and since second mortgages use your house as collateral, it is important to take those risks very seriously.
That is why it is important to make sure that you get the best loan you can. By getting a great loan, you reduce your risk and ensure that your house can never be repossessed by lending agents. Here are some general tips for helping you get the best loan.
- Never Take More Than You Need
It is vital that you take only the amount you need, nothing more. By limiting the amount of money you take on your loan, you reduce your monthly payments as well as the amount you owe, and ensure that your home never gets into negative equity. It is very important that you do not simply take extra money without just cause, else you risk losing your house for no direct gain.
- Keep Your Credit Score High
Second mortgages carry more risk that standard mortgages because they are secondary to your primary mortgage. As a result, your risk profile (credit score) plays an even stronger role with your loan interest rates. That is why it is very important to keep your credit score high. Only with a high credit score can you be sure that you are getting the best rate possible
- Shop With Known Lenders
Because they put the home at risk, people are far more likely to get a second mortgage when they are in some type of financial distress. That makes them vulnerable, and causes less than reputable lenders to try to take advantage of them in their vulnerable state. For second mortgages especially – because the risk is so great – it is always best to go with a lender you can trust. That is one of the only ways to be sure you are getting the best deal.
- Consider Going With Your Current Lender
Check to see if you have the opportunity to get your second mortgage from your current mortgage lender. Often times when you go with the lender you are already using, you are able to reduce your overall fees, as well as have the possibility of making one payment (or, at the very least, allowing you to check with only one lender if things go wrong). Also, because your mortgage lender is one that you have dealt with in the past, you will know their trustworthiness.
- Avoid Default Penalties and Prepayment Penalties
Second mortgage lenders may try to institute fees that you should do your best to avoid. Default penalties are some of the worst, as they fine you for missing a payment. While you may have the financial ability to pay back your loan fairly easily, do not forget the possibility that you simply forget to pay back a loan one month – with default penalties, you could receive a hefty fine. In addition, prepayment penalties are best to be avoided to. If you come into a large sum of money, you should have the opportunity to pay off the loan without incurring any fees or expenses. It is possible to find second mortgages without both of these fees, and you should do your best to locate them.
Making Sure You Get the Best Second Mortgage
As you can see, there are a variety of tips for getting the best second mortgage available. But the best thing you can do is make sure that you check as many places as possible. Only by checking against the competition can you be absolutely sure that you are getting a loan that is at or below industry standard. Second mortgages are still loans taken on your house – even if you have the finances to pay them back, you never know if you will have the same ability next month or the month after. Get the right mortgage the first time and ensure that your finances are not affected.
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Second mortgages are incredibly useful. They give you the opportunity to get a lump sum of money at a semi-low interest rate fairly easily when you need it based solely off of the equity in your home. Second mortgages are one of the only available ways to receive these lump sums without excellent credit and severely high interest rates, making them a tremendous benefit to owning a home.
But as with all loans, there is a lot you need to know in order to be sure you are making the right decision. Here are several things you need to know about second mortgages so that you can be absolutely positive that these secured loans are right for you.
What to Know About Second Mortgages
- Watch Out for Fees
Second mortgages are often fraught with fees. Lenders – even some of the most trustworthy lenders – try to add a number of different and unique fees to these loans with the hopes of getting extra money out of you as you pay back the loan. Some examples of fees include the prepayment penalty (a fee incurred if you try to pay back your loan early), default penalties (fines incurred if you miss a single payment, even if it is due to mail error), and other hidden fees that may occur within the contract. Fees are certainly something to watch out for.
- You Probably Don’t Need Voluntary Insurance
Many of these second mortgages come with what’s known as “voluntary insurance.” This type of insurance is designed to cover the remaining costs of the debt if payment is not covered by defaulting on the home. While there are certainly benefits to having this insurance, often times on second mortgages this insurance is completely unnecessary and expensive. Make sure you need this insurance at all and avoid paying for it if it is deemed unnecessary.
- Prepare for Various Costs – Especially Points
Second mortgages do cost money, which is why they are not advised for small loans. Some of the things you will need to pay include appraisal fees, application fees, and points. Points are an interesting way of reducing your second mortgage loan. They involved buying down your loan by a certain small percentage of your total loan in order to provide you with a lower monthly payment. This lower monthly payment allows you to reduce the total amount you pay over time, simply by purchasing those points up front. They can be valuable, or useless, depending on the savings with purchasing your points.
- Beware of Increasing Payments
One way that some lenders try to woo your business is to provide you with a lower cost up front that explodes into a higher cost at the end of your loan. This is a type of scam – the higher cost at the end of the loan is often so extravagant that some people are forced to default, putting their home at risk. If the monthly price you received for your loan sounded too good to be true, make sure this is not the reason why.
- Consider a Home Equity Line of Credit
Another option you have is to go with a home equity line of credit. This is a better option when you are expecting smaller purchases and when you may need to get more than one loan in the future. They also allow you to pay off interest only during the course of your loan in case the reason for your loan is some type of financial struggle. They are not going to be ideal for all borrowers, but they are much more useful for some, and will not harm your credit to the degree that some of these loans will.
Second Mortgages – A Great Tool, Some Risks
The benefits of being able to get a loan off of your home equity cannot be ignored. But as is the case with all loans, the risks need to be well understood as well. As you can see, there are a lot of facts about second mortgages that are important to know before you decide if one is right for you. Consider them carefully, and contact someone you know that has received a second mortgage to get advice on whether or not it is the right choice for you.
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