How To Get Rid Of A Second Mortgage
If you took out a second home mortgage but now youre following Ramseys 7 Baby Steps, you might wonder at what point you should pay it off. Should you count it in your debt snowball and pay it off in Baby Step 2? Or should you refinance it into your first mortgage and pay it in Baby Step 6?
If your second mortgage is less than half your annual income, treat it as debt and pay if off in Baby Step 2. Dont refinance it. Paying it off isnt unreasonableso long as you make it a goal and stay focused.
However, if your second mortgage is more than half your annual income, refinance it as part of your first mortgage and pay it off in Baby Step 6. Take care of your smaller debts and work your way to paying off the larger debt.
What Happens When You Default On A Second Mortgage
A lender can choose to foreclose when a borrower becomes delinquent on a mortgage loan, whether the mortgage is a first or a second mortgage. If you default on your first mortgage, the lender will very likely begin foreclosure proceedings.
If, on the other hand, you default on a second mortgage, whether that lender will initiate a foreclosure depends mainly on your home’s current value.
Why Would I Need A Second Mortgage And How Do I Qualify
A second mortgage can be a great way for homeowners to consolidate debt. Though second mortgages often carry higher interest rates than first mortgages, these rates are still often lower than high interest credit cards, car lease payments or unsecured lines of credit.
If you use a second mortgage to consolidate debt and help you meet other financial commitments on time, this can improve you credit score and allow you to qualify for a mortgage with a prime lender sooner.
In order to qualify for a second mortgage in second position, lenders will look at four areas:
- Equity. The more equity you have available, the higher your chances of qualifying for a second mortgage will be. If you are purchasing a house, a larger down payment also decreases the risk that a lender takes on. Regular payments towards utilities, telecommunications, insurance, etc, and/or confirmation letter from service provider.
- Income. Lenders want to verify that you have a dependable source of income to ensure that you can make payments.
- Property. Because other factors are risky , lenders need to secure their investment in case you are unable to keep up with mortgage payments.
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Similarities Between Second Mortgages And Refinancing
With both a second mortgage and a cash-out refinance, you can use the cash as you choose. However, you may only want to borrow against the equity in your home if you want to consolidate debt or make home improvements. In each scenario, your house is considered the collateral. This means if you fail to make your payments, it may lead to foreclosure on your home.
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Are Second Mortgages And Home Equity Loans The Same
- While second mortgages are often home equity loans/lines
- A home equity loan/line can also be a first mortgage
- Taken out on a free and clear property
- Or simply used as a first mortgage by choice
When it comes down to it, most second mortgages are home equity loans. And vice versa.
So if you hear someone talking about one or the other, they could be talking about the same exact thing.
This is further complicated by the fact that most home equity loans are HELOCs. Confused yet?
You should be, considering the ambiguity of it alllets break it down once and for all.
While a home equity loan can be referred to as both a HELOC or a closed-end second mortgage, technically it should be the latter.
A home equity loan is a closed-end second mortgage that operates similarly to a first mortgage in that its a fixed loan amount taken out all at once, not a line of credit.
This is a big distinction because it means you pay interest on the full amount borrowed immediately. And you get all the proceeds once the loan funds to use at your disposal.
You could argue that a HELOC becomes closed-end once the draw period ends, as you can no longer borrow from it .
And while a HELOC is often used as a second mortgage, it can also be a stand-alone first mortgage, taken out by the homeowner when their home is free and clear, or it can be used to refinance an existing first lien.
What Lenders Look For When Considering Second Mortgage Applications
When determining whether you are qualified for a second mortgage, lenders examine a number of criteria, including your credit score, debt-to-income ratio, employment history, and current home equity.
As lending standards tightened due to the recent housing crisis, lenders have been much more careful about making loans, especially real estate loans. These days, lenders are seeking borrowers with credit scores close to or above 700. If your credit score is lower than that, you will either be refused for a loan or socked with a much higher rate than prime borrowers with good credit scores.
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The Power Of Interest
For many second mortgage products, you can elect to only make payments on the interest. This creates lower monthly payments, and allows you to have affordable access to the equity in your home before you are ready to sell.
Consider someone who wants to remodel before selling their home or renegotiating their primary mortgage. They can take second mortgage, use those funds to renovate, making interest-only payments. When it comes time to sell or renew, the home is valued at a higher price thanks to the renovations, and then the homeowner pays off the second mortgage.
How Hard Is It To Get A Second Mortgage
Because your second mortgage will be subordinate to your primary home loan, your lender will likely have stricter requirements than those for your original mortgage. You might need a higher credit score, and your interest rate may be higher than your first loan . You’ll also need to demonstrate that you can handle another loan payment.
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Some Common Closing Costs
Typical closing costs include origination fees, lender processing and underwriting fees, credit report, title insurance, reconveyance fee, recording fee, title closing fee and title document preparation fee.
Lenders are required to provide you with an itemized list that estimates your closing cost prior to closing, although your actual closing costs may differ at closing. Sometimes loans also come with repayment penalties, hefty fees for late payments, or balloon payments at the end of the loan.
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Common Uses For A Second Mortgage
Some common uses of second mortgages are to pay for:
- Home improvements.
- College education expenses.
- Consolidation of higher-interest debt, such as credit cards.
Some borrowers use second mortgages to buy investment property. This can be risky, as a downturn in the housing market could lower the value of both properties.
There Are Different Types Of Second Mortgages
What exactly is a second mortgage? These loan products come in a couple of different forms. For instance, a revolving HELOC offers the borrower continuous access to equity as they pay off what they previously owe , much like how a credit card works.
This type of loan can also be a closed second mortgage, which means that you get one lump sum of cash from your equity, and gradually pay it down, much like an auto loan.
HELOCs are typically only offered to those in urban areas who have a strong credit profile. If you are experiencing credit challenges or limited income, private mortgages are likely your only option.
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Know The Pros And Cons Before Taking On A Second Mortgage
Make sure you understand risks involved with second mortgages. Mortgages 101
If you are a homeowner, you might consider taking out a second mortgage if you are in need of a loan. However, because a second mortgage uses your home as equity, you are literally putting your home on the line with this sort of loan. Before taking out a second mortgage, find out what you should ask your lender so you know exactly how second mortgages work and the pros and cons of taking one out.
Whats A Piggyback Loan
A piggyback loan is a third type of second mortgage that is used to when the buyer does not have the 20% or more for the down payment to avoid having to pay Canadian Mortgage and Housing Corporation mortgage insurance. By taking out a separate loan to supplement the down payment to ensure it reaches the 20% minimum, you can avoid the added cost of insurance which on a $500,000 mortgage with only 5% down would be $19,000 and save you money overall. It is negotiated alongside the primary mortgage to pay for the purchase of a home and is not used to leverage existing equity.
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Summary Of Second Mortgages
A second mortgage can be a useful financing vehicle to pay off debts, pay college tuition, or finance an addition to your house. When considering a second mortgage, be sure to consider its merits versus a home equity line of credit. Also, compare rates and fees at several banks, credit unions, and financing companies to get the best deal.
Before applying, get a copy of your credit report and credit score and fix any errors that may appear on your report. Lastly, remember that when you take out a second mortgage, you are tapping the equity in your home, so borrow only for necessary expenses.
This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.
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What Happens To Underwater Homes
If your home is underwater , your second mortgage is effectively unsecured. So, if the second-mortgage holder foreclosed, the foreclosure sale proceeds wouldn’t be sufficient to pay anything to that lender.
In most cases, if you’re underwater and fall behind on payments for your second mortgage, the holder of the second mortgage probably won’t start a foreclosure. That’s because all the money from the foreclosure sale would go to the senior lender. But the second-mortgage lender could still sue you personally for repayment of the loan.
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One Disadvantage To Consider
One advantage a home equity line of credit often has over a second mortgage is that as you repay the loan, you may gain access to additional credit because the line of credit replenishes itself as you repay principal, which doesn’t occur with a second mortgage.
However, lenders can and will trim lines of credit for a number of reasons, but generally will not pull a second mortgage unless you are behind on your payments so, in an environment where housing prices are falling and lenders are skittish, you might find a second mortgage a more reliable source of funds than a home equity line of credit.
Should I Get A Second Mortgage
Second mortgages are temptingbut theyre just not worth it. Sure, lenders package them like a gift. But take away the inflated promises and youll see them for what they really are: debt repackaged as debt.
If youre considering a second home mortgage, here are the main reasons why you should avoid them at all costs:
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Key Aspects Of Second Mortgages
A second mortgage is subordinate to the first mortgage, which means that in the event of default, the first mortgage will get priority in terms of repayment. Only after the first mortgage has been completely repaid from the sale proceeds will the 2nd mortgage lender will be able to recover the loan.
A mortgage is always taken out against the equity in your home, and second mortgages are no exception. The loan amount that the second mortgage lender will offer you will depend on the equity built up in your home.
Interest rates on a second mortgage are higher than those charged on the first one. This is because the second mortgage lender is taking a higher risk, as he gets second priority in case of default. That said, working with a mortgage professional can help you reduce these rates and obtain the right product for your financial situation.
Reasons To Get A Second Mortgage
People get second mortgages for all types of reasons. Sometimes, they want to add on to their house or make other improvements. Other times, they want to access the equity in their home to start or buy a business . Sometimes, they want to take a nice vacation or finance a large purchase.
Some of the most common reasons people get a second mortgage are:
- To make improvements to property
- To invest in a business
- To pay off higher-interest debt
- To finance a vacation, wedding or other large purchase
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Choosing A Second Mortgage For The Right Reasons
To be sure, applying for a second mortgage has distinct benefits. You gain access to the equity in your home for a variety of potential expenditures.
The most common use for second mortgages is getting rid of high-interest consumer debt, like . This of the burden that this would take off your shoulders not having any more credit card debt. With the average credit card interest rate being 15%, you could save a lot of money by leveraging a second mortgage.
The second most common usage for second mortgages is to finance home renovations. Home improvements add value to the house and guarantee a better price should you decide to sell the house in future.
This means that you are using the money from an asset to increase the value of that asset itself. Those with mounting credit card debt can also take out a second mortgage for debt consolidation purposes to make repayments more affordable and manageable.
Other uses for second mortgages include:
- Rainy day fund
- Business or real estate investments
- Medical expenses
THE RISKS INVOLVED
A discussion on how do second mortgages work is incomplete without mentioning the risks involved. Although such a mortgage can prove to be very useful when you need a lot of cash quickly, dont forget that like any other loan taken against an asset, it puts that asset at risk.
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How Do Second Mortgage Rates Compare To Regular Mortgage Rates
Rates on a second mortgage are higher than the rate youre offered on your first mortgage. This is because the first mortgage will be paid off before the second mortgage if you were to default on your payments. Therefore, the second mortgage is higher risk than the first just because it’s second in line.
How Do You Take Out A Second Mortgage On Your Home
- You can take one out at the same time you take out a first mortgage
- Or later after you close your first mortgage
- Many homeowners open HELOCs after the fact
- So they have access to cash if and when needed
Its pretty common for certain banks to specialize in second mortgages, but often youll be getting your first mortgage elsewhere.
In the case of the piggyback second, you would likely have the first mortgage lender point you in the direction of a second mortgage lender.
And by that, I mean theyd likely have a lending partner they work with that only offers second mortgages.
They would probably facilitate the transaction to ensure everything ran smoothly between the two lenders, handling all the paperwork so you wouldnt have to do twice the amount of work, or even interact with the loan officer or loan originator at the other bank.
The same goes with mortgage brokers theyre typically able to line up financing for a first and second mortgage with two different lenders concurrently.
You would still need to be underwritten by the second lender, as you would the first, and gain approval and close on the loan at the same time the first mortgage closes. You may even have to pay an appraisal fee to that lender as well.
If you already have a mortgage and simply want a second one, youd shop for the mortgage as you would any other mortgage, and then you would apply in a similar fashion.
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