Can You Truly Afford To Buy A Second Home
First things first, youre going to need to make sure you can afford a second mortgage. At this point, you wouldve ideally paid off your first mortgage fully, or at the very least made, consistent, timely payments. Moving forward, there are some new numbers to which you should pay extra attention to.
Second mortgage interest rates on average tend to be about a quarter of a point to a half a point higher than the interest rates on first mortgages. Youll have to prove to the bank that you can cover both your first and second mortgages with money to spare.
In the days before the Great Recessions housing crisis, it was easier to leverage a first home purchase to finance a second home. These days, lenders are more conservative when deciding whether to issue loans for secondary homes. In the grand scheme of things, though, the interest on your mortgage is just a part of the overall view of things. Keep in mind that down payments on second mortgages tend to run from 10% to more than 20%.
Should You Get A Second Mortgage
Many people consider getting a second mortgage to buy another house. This would mean they are not yet ready to sell or move out of their current home, but would like a second home they can eventually move into or use as a holiday retreat.
In some cases, they may want to rent out their first or second home read the section, ‘Buy to let or consumer buy to let’, further down to learn more about this.
Advantages of taking out second mortgages:
If you can afford it, a second mortgage is likely to be a cheaper loan than a secured loan or second charge mortgage
Disadvantages of second mortgages:
Is expensive to pay for two mortgages at the same time
Stricter affordability checks
Puts your current home at indirect risk
A second mortgage, despite not being linked to your current home or existing mortgage, still poses an indirect risk to it. If you are unable to repay your second mortgage, then you may look to your existing property as a financial back up plan by selling it off.
However, this last resort is not as bad as it sounds because your 2nd mortgage means you are the owner of a new property, which you could move into in the event that you had to sell your existing home.
Whats Required To Get A Second Mortgage
Remember, second mortgages are risky for lenders because if your home is foreclosed, the lender of your first mortgage gets dibs on your house. So, when it comes to issuing second mortgages, heres what lenders will want to know:
- You have good credit. If youve had trouble paying off your first mortgage, good luck getting a second one. You must prove to your lender that you consistently pay your mortgage paymentsotherwise, they wont consider your application.
- You have equity. In most cases, lenders want an appraiser to look at your house and calculate your equity. While you can get a rough estimate based on how much mortgage remains and how many payments youve made, an appraiser will take a closer look at the market value of your home to give an accurate number.
- You dont have a lot of debt. Just like when you applied for your first mortgage, lenders want to know you have a steady income and youre not up to your neck in debt. Your lender will want to review your pay stubs, tax returns and bank statements.
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Interest Rates And Fees If You Borrow On Amounts You Prepaid
You pay either a blended interest rate or the same interest rate as your mortgage on the amount you borrow. A blended interest rate combines your current interest and the rate currently available for a new term.
Fees vary between lenders. Make sure to ask your lender what fees you have to pay.
You may not have to make any changes to your mortgage term.
What Are Second Mortgages
A mortgage is a loan secured by your home. A second mortgage is one you take out when you already have a first mortgage.
Second mortgages are riskier to lenders than first mortgages. Thats because in a foreclosure sale, the first mortgage gets paid off first. The second mortgage may not be completely repaid from the proceeds of the sale.
Second mortgages are cheaper than most other loans because they are secured by real estate. But they come with higher rates than first mortgages.
The most common types of second mortgage are home equity loans and home equity lines of credit . It is possible to have one of those without having a first mortgage but theyre relatively rare.
Related:Home equity loan vs line of credit
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Taking Out A Second Mortgage
Once you understand how a second mortgage works and deem it to be the best course of action for you, taking out the additional mortgage is similar to how you got your first mortgage. You will likely need to provide proof of your employment, income, credit score, and other debts. You will also need to have sufficient equity in your home. You will need to get your home appraised to get an estimate of its current value so that the lender can assess the equity. The loan amount and interest will reflect all of these factors.
You can begin the application process by going to your bank or credit union and applying for a loan through them. Inquire about whether the lender charges application, origination, or appraisal fees not all lenders charge these fees. Although you should be prepared for the interest rates on a second mortgage to be a bit higher than on your first mortgage, they will still generally be lower than unsecured loans such as personal loans or credit cards.
You don’t have to get your second mortgage from the same lender where you received your first mortgage.
Types Of Second Home Mortgages
Lets look at two forms of second mortgages:
- Home equity loan. With a home equity loan, your lender gives you a stack of money based on your equity, and you repay the lender every month. Because its a one-time lump sum, home equity loans come with a fixed interest rate, so monthly payments dont change.
- Home equity line of credit . A HELOC is when your lender allows you to borrow a large amount of your equitybut not as a lump sum. Its more like a credit card where you have a borrowing limit, and you only pay for the amount you borrow. After the borrowing time frame has ended, you must pay off your accountor else your lender will take your house!
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Common Uses Of Second Mortgages
Consider how you plan to use the funds from your loan. Its best to put that money toward something that will improve your net worth in the future. This is because youll need to repay these loans, theyre risky, and they cost a lot of money. Here are a few common ways to use a second mortgage.
- Home improvements: Renovations are a common use for second mortgage funds because the assumption is that youll repay the loan when you sell your home with a higher sales price.
- Avoiding private mortgage insurance : It might be possible to avoid PMI with a combination of loans. For example, an 80/10/10 strategy or piggyback loan uses a second mortgage to keep your primary mortgage’s loan-to-value ratio at or below 80%. Just make sure it makes sense, compared to payingand then cancelingPMI.
- Debt consolidation: You can often get a lower rate with a second mortgage, but you might be switching from unsecured loans to a loan that could cost you your house.
- Education: You may be able to set yourself up for a higher income. But as with other situations, youre creating a situation where you could face foreclosure. Standard student loans might be a better option.
Beware of risky loan features like balloon payments and prepayment penalties.
How Do I Buy A House If I Already Own One
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To Fund Home Improvement Projects
Cant wait to add the backsplash in the kitchen? Always wanted a swimming pool but never had the cash? Homeowners sometimes take out a second mortgage to renovate their houses.
The idea is that if you renovate your house, youll increase the market value of your home, getting you more equity. But that idea assumes the market value of your home will go up. However, if the value of the homes in your area goes down, youd have a major problemand no equity.
Second Mortgage: How It Works And When To Get One
Edited byChris JenningsUpdated October 13, 2021
Our goal is to give you the tools and confidence you need to improve your finances. Although we receive compensation from our partner lenders, whom we will always identify, all opinions are our own. Credible Operations, Inc. NMLS # 1681276, is referred to here as “Credible.”
If you have a first mortgage, and youve thought about consolidating your debt or financing a few home improvements, you might have considered taking out a second mortgage.
A second mortgage loan where you borrow against your homes equity can give you the cash you need for important financial goals. However, theyre not for everyone. Second mortgages come with some risk.
Heres what you should know about second mortgages:
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Can I Use A Home Equity Loan For Anything
A home equity loan can be used to purchase anything lenders typically dont have rules for its usage. Home equity loans can be used to pay for things like medical expenses or your dream wedding.
Although you can use it to finance those things, its better to use it for refinancing high-interest debt or home-renovation projects. Using it for the former can help you get out of debt quicker, provided you secure a lower interest rate. Using it for the latter can increase the value of your home.
If you use it for other purposes, such as investing or funding a business, theres no guarantee that youd see a good return on investment, and you could lose money.
Using A Second Mortgage As A Down Payment
Some people use a second mortgage to cover a down payment or even closing fees that they can’t otherwise afford. Others take out what is known as a “piggyback” second mortgage to qualify for their main mortgage and avoid paying Private Mortgage Insurance even if they don’t have enough to make a down payment of 20% on their home. For example, instead of paying 10% of the home value with a down payment and 90% of the remaining value with a mortgage that requires PMI, a borrower can qualify for a 10% down payment, 80% of the mortgage, and 10% with a piggyback second mortgage.
But a second mortgage or a piggyback second mortgage both come with higher interest rates. You could also become underwater on your mortgage. Making a down payment of 20% will allow you to avoid paying PMI, qualify for lower interest rates on the first mortgage, and start your home loan on better financial footing. More importantly, you can avoid potentially losing your home.
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How Does Getting A Second Mortgage Work
Its where a loan secured on the property is given from a source other than the original lender.
The second lender takes second priority to the first lender. This means if the property ever needs to be sold, the first lender will have first call on equity in the property.
As with any mortgage secured on your property, failing to repay it could mean youll lose your property.
Determine The Location Of Your Second Home
When buying a second home, its very important to consider the location. If you plan to use it as a vacation home, youll want it to be far enough from your primary living space that it feels like youre getting away from the world, but not so far away that you rarely get to travel there. If you plan on hosting family a lot, you may also want to consider looking for a property thats centrally located within a few hours of everyone.
Some other factors related to location that potential buyers ought to think about are the attractions in the area that drew you there in the first place, quality of the surrounding neighborhood especially if youre renting the property out to other tenants and what the weather/climate is like throughout the year.
For example, you might think moving to Florida sounds great but end up in a town further from the beach than you expected or realize you dont enjoy the heat and humidity. Do your research before purchasing a property.
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You Just Need Some Breathing Room
Breathing room is great, but if the forces that are suffocating you are not dealt with, you wont make any progress. If your $800 monthly utility bill is killing you, turn down heat, turn up the A/C, quit watering your lawn or turn out the lights. If you dont act, youll soon see another $800 energy bill, and youll have to figure out how to pay that. Borrowing against your home for monthly expenses that you cant reduce is not a good idea. Instead of this, start looking for the best side hustles that allow for some extra income!
Is It Better To Refinance Or Take Out A Second Mortgage
A second mortgage is a loan or line of credit you take against your homes equity. Refinancing allows you to access equity without adding another monthly payment. However, youll also need to pay more at closing to finalize your new loan. Cash-out refinances are best for consolidating large amounts of debt.
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Getting A Second Mortgage If You Have Bad Credit
Although second mortgages are often difficult to qualify for with bad credit, its not impossible. Obtaining a second mortgage with a low credit score likely means that youll be paying higher interest rates than those with good credit. However, this loan can be beneficial in helping you pay off high-interest credit card debt or increasing your homes value through home improvements.
In order to qualify for a second mortgage with less-than-perfect credit, you must meet the following qualifications:
- You have a credit score of 620 or higher
- You have a DTI lower than 43%
- You have 15 20% equity in your home
- You have proof of on-time monthly mortgage payments
- You have a strong income history
Before applying for a second mortgage, make sure that youre able to meet all of these qualifications. If not, you may want to consider boosting your credit score before applying. However, you may still be able to qualify now if you are able to use a co-signer on the loan.
You could also consider looking into alternative financing options to help pay for your home improvements or debt consolidation. Both personal loans and cash-out refinances are good options to use if you have trouble qualifying for a second mortgage.
How Does A Cash
A traditional mortgage refinance and cash-out refi both involve taking out a new loan to pay off your existing mortgage. With a traditional refinance, you borrow about the same amount as you currently owe and try to get a lower interest rate, different term or both.
Your interest rate and term could also change with a cash-out refi, but the idea is to borrow more than you currently owe and use the extra cash for something else.
If youre just looking to lower your interest rate, a traditional refi may be the better option because it tends to have lower rates than a cash-out refi.
A cash-out refinance can be a great option if you were already planning to refinance your home loan, and youve built up equity in the home, says Andy Taylor, GM of Mortgage at Credit Karma. Its essentially taking out another, larger loan to pay off your original mortgage, and using the extra money borrowed for cash in-hand.
Generally, the maximum is 80% of your loan-to-value ratio, or LTV. For example, if your home is worth $100,000, you may only be able to borrow a total loan amount of $80,000.
To qualify for a cash-out refinance, youll generally need to get your home appraised. The appraisal value may impact how much money you can take out, as it determines the homes value for the loan-to-value ratio.
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Advantages And Disadvantages Of A Second Mortgage
Taking out a second mortgage means you can access a large amount of cash using your home as collateral. Often these loans come with low-interest rates, plus a tax benefit. You can use a second mortgage to finance home improvements, pay for higher education costs, or consolidate debt. The risks of taking out a second mortgage however are not unsubstantial, nor inexpensive. Expect to pay closing costs, appraisal fees, and credit checks during the process, and you run the risk of losing your home if you can’t make payments.
Second mortgages allow you to access the untapped equity in your home for cash.
HELOCs and home equity loans can help pay for big ticket items like college or major renovations.
Interest rates on second mortgages are lower than on private loans or credit cards.
If you can’t pay a second mortgage back, you risk losing your home.
It costs money to close on a second mortgage.
If your home doesn’t appraise high enough and you don’t have enough equity in your home, you may not qualify for a second mortgage loan.