If a homeowner needs cash to finance large purchases or several small ones, one option they have is to get a second mortgage. Like their first mortgage loan, it also uses their house as collateral.
What is a Second Mortgage?
A second mortgage is one that a homeowner takes out on their home while their first mortgage is still in effect. With a second mortgage loan, the homeowner is getting access to their equity in the home. If the balance on a $300,000 home is $250,000, this means that the homeowner’s equity will amount to $50,000. It is easier for a homeowner with poor credit to qualify for a second mortgage since it is secured by the home. If the homeowner is unable to repay their loans, the house will be sold and the proceeds used to repay both first and second mortgage loans. The first mortgage will be first in line for repayment; if the proceeds are not enough to cover both loans, the second lender may not be repaid what they are owed. For this reason, the interest on a second mortgage is usually greater than on a first mortgage.
Types of Second Mortgage Loans
Homeowners who get a second mortgage loan can access the money in one of two ways:
Home Equity Loans
If the borrower chooses this option, they will get a single lump sum based on their equity in the home. They will have an interest rate that is set from the start and a fixed period over which to repay the balance. Since home equity loans come in the form of a single sum, they are best for large one-time purchases. Typical uses include:
• Home renovation
• Paying for a second home
• Paying a child’s college tuition
• Debt consolidation
Home Equity Line of Credit (HELOC)
This type of loan functions like a credit card in that the borrower gets a reusable line of credit. As they pay down the balance, they have opportunity to re-borrow up to their credit limit. The similarity to a credit card makes a HELOC better for daily use where the borrower will be making multiple small payments.
It is important for homeowners to remember that if they default, their house will go into foreclosure. By adding to their debt, they could be making repayment of their old loans more difficult. They should carefully analyze their finances to make sure that they can afford a second mortgage.