When To Consider Home Equity Financing
Typically, HELOCs are used for home improvements such as a new roof, updated kitchen, refurnished basement and other projects of that nature. This is because HELOCs give you flexibility to use as much or as little of the line of credit as needed. This flexibility lets you pay for materials and work as your project unfolds, whether you prefer weekend projects or longer term renovations.
Second mortgages, on the other hand, are generally used to pay off larger, more significant debts that youve already incurred. For example, if youre in over your head with credit card debt, taking out a second mortgage to pay off all outstanding balances could help, especially if you are able to secure a better interest rate on your second mortgage repayments than you would with credit card repayments. Some small business owners also take out second mortgages on their homes to keep their company afloat during lean times. Speak with your financial professional about options that are right for you.
Qualifying For A Second Mortgage
The qualification requirements for a second mortgage vary depending on what type of junior lien you’re seeking and the lender you choose.
But there’s one qualification requirement that’s a constant: For any stand-alone second mortgage, you’ll need to have accrued sufficient home equity to borrow against. The amount you can borrow with a second mortgage usually tops out at 85% of your equity.
The amount you can borrow with a second mortgage usually tops out at 85% of your equity.
A of 620 is the typical minimum for a second mortgage. Lenders may ask for a higher score, especially if you’re trying to borrow a large amount. A higher credit score can also help you get a lower rate.
Just as with a primary mortgage, your debt-to-income ratio how much of your monthly earnings goes toward monthly debt payments should be less than 43% for a second mortgage. Lenders can require a lower DTI if they choose, however.
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.
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What Happens To Homes With Equity
If you have equity in your home , your second mortgage is at least partially secured. So, the proceeds from a foreclosure sale will pay off the second mortgage in part or in full.
In this situation, the second-mortgage holder will probably initiate a foreclosure after you fall behind in payments on that loan because it will recover part or all of the money it loaned to you once the property is sold at a foreclosure sale. The more equity in the property, the greater the likelihood that the second-mortgage holder will foreclose.
Determine Why You Need Money And Whether You Need Another Loan
First, figure out your goals. Do you want to replace the roof? Install a pool? Pay off credit card debt? Taking on debt is a big responsibility, and youll want to make sure the reason would drastically improve either your finances or your home.
With any big home renovation project, most homeowners want to increase their homes value for when its eventually resold, in addition to whatever quality-of-life improvements come from it. Youll have to do the math on whether a remodeled kitchen or a new fence would tick both boxes.
Its also worth weighing the mortal risks of a second mortgage. If you default on payments, your home could go into foreclosure and youd have to pay back not only the mortgage, but also the amount borrowed through the home equity loan or HELOC.
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Benefits Of Cash Out Refinancing
The benefit of cash-out refinancing is that you can use the equity in your home to take out funds for whatever purpose you need it and you can select to amortize the mortgage over a long period to keep the payments low and repay the loan gradually over a long period. You still carry one single mortgage. If you happen to have good credit and your LTV is below 80%, you can receive very attractive interest rate from an A lender.
Second Mortgage Vs Refinancing: How Are They Different
Now be careful not to confuse a second mortgage with a refinanced mortgage. A second mortgage comes with a second monthly payment along with your current monthly payment.
Meanwhile, refinancing means youre replacing your current mortgage with a new mortgage that has a different set of termsso you stick with only one monthly payment.
With a second mortgage, your primary lender holds the lien so if you stop making payments , they can take back your house .
Your second lender only gets their money back if your primary lender gets all their money back from auctioning off the house.
All this to say, your second lender is taking on a higher risk and will probably charge you a higher interest rate as a result compared to doing a refinance.
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When To Consider A Home Equity Line Of Credit
If you need extra money intermittently, a variable-rate home equity line of credit might be your best choice. Once the lender approves you for a maximum line amount, you can access the available funds as you need them. Use your Home Equity Line of Credit Visa Access Card anywhere Visa is accepted, write a check, visit a branch or ATM, or log in to Online or Mobile Banking and transfer money to your U.S. Bank savings or checking account. You may have ongoing access to funds for 10 years, called the draw period, following the date you open your line of credit. After the draw period you’ll have a repayment period of 20 years.
Monthly minimum payments are variable and based on the amount of the line balance and the variable interest rate. As you pay the money back, the funds are available again on your HELOC. This provides you with a renewable source of funding during the 10-year draw period. This is a good option if you anticipate the need to make periodic payments for tuition or remodeling.
Although a home equity line of credit provides ongoing access to available funds, which may be tempting for some people, there are some critical things to consider.
- You have to pledge your home as collateral
- If you dont make payments, your property can go through foreclosure
- Your credit score is on the line if you arent diligent with your payments
You Dont Negotiate With The Lender Early On If You Get Into Trouble
Second mortgages can pose a particular threat to those in financial trouble.
Companies that lend second mortgages may hold only junior liens. But they can and do foreclose on borrowers who fall seriously behind on payments. In other words, you need to keep up with HELs and HELOCs as much as you do your first mortgage.
Foreclosure isnt always the end of it
Even after a foreclosure, you may remain vulnerable. If the sale of your home doesnt raise enough to cover all their losses on your secured borrowing, lenders can often still come after you for the shortfall. And that can happen even in blood-from-a-stone scenarios.
Of course, bankruptcy may provide relief. But your credit score can then take a decade to begin to recover.
Your best bet for avoiding foreclosure is to negotiate with your lenders early on. But maybe youll be tempted to put off getting in touch until you have some good news.
Dont be. Counterintuitively, someone in a bad situation can have more leverage than someone in a slightly better one. Suppose your home is underwater, meaning the secured debt you owe on it exceeds its market value. Or your income and assets are currently very low.
Lenders may hate those things but they may also recognize the futility of foreclosing or being inflexible over payments. They may decide that their best chance of eventually getting their money back is to give you some space to get back on your feet. So work with them early on.
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What Exactly Is A Second Mortgage
Lets start with the basics. While a primary mortgage refers to the first loan undertaken by homeowners for property, a second loan acquired for the same property is called a second mortgage.
A second home mortgage is granted before the primary one is fully paid off. The total amount, however, depends on the equity of the house bought through the first mortgage. Here, equity refers to the value of a property minus mortgage debt and loans, and is calculated by subtracting the value of the property from the remaining balance left over from the primary mortgage.
Essentially, the higher your property equity, the higher the chances of getting a second mortgage. A second home mortgage is the loan that a lender will present to you based on the equity youve built up over the years. The key advantage to this kind of mortgage is that it will allow you to access up to 95% of the equity youve already built up just by owning the property.
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Second Mortgage On Rental Property: Pros & Cons
Taking out a second mortgage on investment property assets has served investors as a great alternative source of financing. If, for nothing else, the more ways an investor knows how to secure funding, the more likely they are to secure an impending deal. However, it should be noted that a second mortgage on rental property assets isnt without a few significant caveats. Like nearly every strategy used in the real estate investing landscape, one must weigh the pros and cons of second mortgages. Only once an investor is certain the positives outweigh the negatives should they consider using a second mortgage on investment property assets. Here are some of the most common pros and cons of taking out second mortgages on rental properties to help you form your own opinion.
Pros And Cons Of Second Mortgages
If youre considering a second mortgage, there are some pros and cons to keep in mind before you take one out:
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The Difference Between A Second Mortgage & A Refinance
From your first mortgage repayment, you are building up the equity in your home. This equity can be used to borrow money when you need it. One question our mortgage broker team is often asked is whether its better to refinance or take out a second mortgage. Both options have their benefits, but which you choose is dependent on your circumstances. Well look at the differences between the two to help make that choice.
Advantages Of A Second Mortgage
- Dont have to refinance your first mortgage
- Dont always have to get a new appraisal
- May be able to draw money over time and only pay interest on what you borrow
- Good way to build your credit if you pay on time
- Loans are often cheaper than other types of debt
- Some loans are interest-only, which makes them cheaper
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How To Use The Second Mortgage Calculator
The second mortgage calculator is a breeze to use. All you have to do is input your home value, your first mortgage balance and if exist your second mortgage balance and click to see the result. i. For instance if your home is worth 450K just type in 450000 . The calculator will only accept numbers so do not use any comma or decimal point. Next you need to enter your first mortgage balance in the same format as above. If you have an existing second mortgage, enter the amount in the field for second mortgage otherwise you can leave it blank.
There Are Different Kinds Of Second Mortgages
Second home mortgages can come in the form of different loans. The options allow homeowners to pick the one that is most suited for their existing loan and equity history. The two kinds of second mortgages are:
1. Home equity loans: This type of second mortgage will allow you to use the loan money only once. After the lump sum is used and spent, there will be no more money available to use.
2. Home equity lines of credit: The second kind of second mortgage functions like a revolving loan. The homeowner is extended a line of credit, which allows for flexibility in drawing out the money when needed, paying it down, and using it over and over in different circumstances.
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Second Homes Vs Investment Properties
The difference between second homes and investment properties is that a second home is a property that you occupy for a portion of the year. In contrast, an investment property is a property that you do not live in for any portion of the year and instead own for income-generating purposes. You will find that mortgage rates and down payment requirements are higher for investment properties than for second homes. This is because lenders find that homeowners are more likely to stay in possession of second homes than an investment property if they were ever to find themselves in financial trouble. The requirements are similar for both forms of properties, but lenders may require that a borrower has experience managing properties before approving a loan for an investment property.
The Value Of The Tax Deduction
So the tax deduction that second mortgage interest potentially brings is one major advantage of second mortgages over other financing alternatives. With a fixed-rate second mortgage, you have the certainty of knowing exactly what your payments will be over the life of the loan, whether it be 10 or 15 years.
That’s in contrast to an adjustable-rate second mortgage or a home equity line of credit where the interest rate adjusts, depriving you of that certainty.
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The Mortgage’s Recording Date Usually Determines Priority
Generally, priority is determined by the date the mortgage or other lien is recorded in the county land records. Though, some liens, like property tax liens, have automatic superiority over essentially all prior liens.
First mortgages are, as the name suggests, typically recorded first and are in a first-lien position. Second mortgages are usually recorded next and are therefore in the second position. Judgment liens, if any, are often junior to a first mortgage and possibly a second mortgage, as well as perhaps other judgment liens previously filed by other creditors.
How A Home Equity Loan Works
A HEL uses the equity in your home as collateral. Equity is what your home is worth minus the existing mortgage.
You generally receive the loan proceeds as a lump sum with a loan term ranging from five to 30 years, and you will have to repay it plus interest in fixed monthly installments. There may also be upfront fees. Fortunately, the interest rate is generally fixed and doesn’t change over time, which makes for a predictable monthly payment. But if you don’t repay the HEL, the lender could foreclose on your home. So, be certain you can make the monthly payments your loan requires. A loan calculator like the one below is an invaluable tool as you plan out how you’ll manage future HEL payments:
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Adding A Second Mortgage To Your Debt Payment Plan
After you take out a second mortgage, include it in your debt payment plan. Since the interest rate is higher, it should not be treated the same way as your primary mortgage. Work to pay off the debt from a second mortgage as quickly as possible to avoid becoming mired in more debt.
If you are considering a second mortgage for any reason, consider carefully the reasons why you are doing it and whether or not you can truly afford the financial and emotional costs of a second mortgage, including the potential loss of your home.
The costs of a second mortgage depend on various factors, including your home price, down payment, loan term, property taxes, homeowners insurance, and interest rate on the loan .
You will usually be better off if you can save up and pay cash for most of your needs or work with debt professionals to clear up your debt without the same risks as using a second mortgage to pay them off. Input the above-mentioned information into a mortgage calculator below, which lets you see what your monthly mortgage payment may amount to.