Many people do not realize that they can take a second mortgage loan on their property. A second mortgage, like the name suggests, is basically another mortgage taken against the value of your home. Just like the original mortgage, the second mortgage is secured by your house. In case you fail to pay the loan amount, the bank would have power to take possession of your home. Second mortgages have become very common these days because of the incredibly low interest rates and increasing worth of houses.
Types of Second Mortgages
Before you decide to take a second mortgage, you must realize that there are 2 types of this loan. The 2 distinct types are:
- Home equity line of credit loan
- Closed-end second mortgage
The home equity line of credit loan works similarly to a credit card and therefore, you can spend according to your needs. In this case, the interest rates are flexible. It is to be noted that the maximum amount for this type of loan usually depends on a percentage of the appraisal value.
On the other hand, the closed-end mortgage involved a fixed loan amount, which must be repaid within a fixed time period. This is perfect for those who have a one-time need for a fixed amount.
The Right Reasons to Take a Second Mortgage
It is essential that homeowners understand that there is danger associated with taking second mortgages. Most people take this loan to fund huge expenditures like buying another home, repairing and improving home, paying college tuition, or to pay off another loan. While these are acceptable, it is not recommended to take such loans to pay for something frivolous like new clothes or a vacation.
In case of need, however, this method is the best as it has many advantages over the alternative funding techniques available. Some of the key advantages of second mortgages are debt consolidation, tax advantages and favorable interest rates.
One of the main reasons why most people are inclined towards taking second mortgage is because it allows access to a large sum of money which they can use for any purpose. Lenders also consider this type of loan as safer than other methods as these loans are secured by the property. This is also why homeowners enjoy lower interest rates on second mortgage home loans.
In addition, they enjoy tax benefits of getting second home loans. This is because the second mortgage interest is tax deductible.
The Risks Associated with Taking This Home Loan
The biggest disadvantage of a second mortgage is that it is secured by your house and there is always a possibility that you will lose the home if you are unable to repay. Also, significant fees (around 3% – 6% of total loan) are associated with getting a second mortgage. There is a chance that the interest rate will not be as impressive as expected, especially for homeowners who do not have an impressive credit score.
There is another major concern is case of dramatic market change. If home values suddenly drop in the future, you will be negative in your house in terms of equity.
In conclusion, a second mortgage is just a new debt which has to be repaid. It is of course great if you can use it properly. However, in many cases, individuals use the home loan to take additional debt. The second mortgage is indeed a great way to fund major expenses but it is not recommended to take this loan to pay for things that are not absolutely necessary.