Trying to find an adequate loan can to satisfy your needs can be a time-consuming and rather daunting task. This is especially true when we talk about mortgage loans. There are various types of mortgage loans from which we can choose. But, for you to make the right decision, you must understand the pros and cons associated with each type of mortgage. One type of mortgage loan that is widely used is the second mortgage loan. Before deciding whether this type of mortgage loan will satisfy your financial needs, you should understand some of its basic advantages and disadvantages.
In addition, you should also identify the characteristics of an adequate loan for you. Not every mortgage offer is in accordance with your needs and preferences. Thus try to have a clear picture of what would be an ideal loan for you.
The second mortgage loan explained.
As with the original mortgage, a second mortgage loan is a loan guaranteed with collateral. The collateral is your home. There is one major difference between a second mortgage and an original (first) mortgage. The second mortgage uses the equity you have accumulated in your home. You can build your equity in two basic ways. First, the equity could be accumulated during the years as you pay out your original mortgage. Next, your equity can increase with the increase in the market value of your property.
There are two basic forms of the second mortgage, these are home equity loans (lump sum) and home lines of credit. If approved for a home equity loan, the lender will give you a lump sum of funds at once. The repayment of a home equity loan is made regularly over a pre-specified period, which means that you will have a fixed monthly payment. In addition, the common type of interest rate for this form of the second mortgage is fixed interest rate.
After approval of the home equity line of credit, you can use the available funds as you need them. An adjustable interest rate is common for the home equity line of credit, unlike the home equity loan.
Because of the importance for every borrower to grasp the pros and cons of each mortgage, the basic pros, and cons of second mortgage loans.
Pros of the second mortgage
Interest rates – because a second mortgage is a form of secured debt, it bears a lower interest rate compared to other types of loans. Since your loan is secured against your home, the risk for the lender is lower. Namely, if you default on your loan, the lender can cover the loan amount by selling the collateral (your equity).
Loan amount – the fact that a second mortgage is a secured loan, you are able to borrow larger amounts. The amount you can borrow can be up to the value of your equity.
Tax benefits – are possible for the interest cost for a second mortgage. Namely, the interest paid could be tax-deductible, but for this matter, consult your adviser.
Spend it as you want – is yet another advantage of second mortgage loans since you receive the money as a lump sum or available to you as you need. Nobody is telling you how to spend these funds. You can spend them on whatever you want. However, this can also be a drawback for financially irresponsible people. In a way, if you are not responsible with the money, you could end up spending them in unproductive ways. This means that you will have no benefit from the second mortgage, but you will have an obligation to repay it.
Cons of the second mortgage
Foreclosure – is one of the biggest risks of a second mortgage loan because you are using your home as collateral. If for some reason, you fail to pay your monthly payments, your lender has the right to take your home through foreclosure. The consequences for you are obvious, you can be left out on the street. Thus, make a wise decision regarding the reason for taking a second mortgage. Do not use this type of mortgage for regular purchases.
The cost of the second mortgage – can be a bit higher. There are different activities associated with this mortgage during the application process and approval process. All these activities will cost you money. You will have to bear the cost for appraisal, credit check, origination fees, plus other fees depending on the lender (Note: always look for the hidden fees).
Interest rate – although it has been mentioned as an advantage, the interest rate is also the disadvantage of second mortgage loans. Namely, while this type of mortgage charges lower interest than credit cards, it charges a higher interest rate than the original (first) mortgage. In case you fail to make payments, the first in line to repay its loan is the lender of the first mortgage. The second mortgage lender will cover its loan with the money left after the first lender is paid off.
Uses of second mortgage loan
As with every other loan, the second mortgage loan also has its general purposes. Namely, you should be careful about the reason you are taking on a second mortgage. Make sure that you use the money from your second mortgage responsibly and don’t spend them on everyday purchases. Don’t spend the money from your second mortgage on vacations, either. Just remember that a second mortgage is secured with your home. The most common uses of second mortgage loans are:
- Debt consolidation – to secure a lower interest compared to the one you are paying on your current debt. Furthermore, you could take a second mortgage to consolidate all of your monthly payments into one payment.
- Home repair and improvements – can be a productive use of your second home. This is under the assumption that these repayments and improvements will increase the value of your home.
- Buy a second home – some borrowers use the funds from a second mortgage to buy a second home. The second property could also be an investment property, which can be further rent and earn you a rental income.
With the original mortgage, you purchase a home or property and build equity over time by repaying the principal amount. When it comes to second mortgage loans, you are putting the accumulated equity as collateral. This means that you must pay close attention to using the funds obtained with second mortgage loans. Namely, you should not risk your equity if you plan to use the money from second mortgage loans for unproductive activities. Use these funds in a way that will bring you some benefit (financial benefit) in the future. For instance, you can make home improvements, buy a second home (investment property) or consolidate your debt.
The way you will use the funds will make the difference whether you will enjoy the benefits or be hit with the drawbacks. Always gather enough information before making any financial decision.