By Suzy McCoy
You’ve probably received advice not to take on more debt when you are already carrying a significant load. However, there may be occasions that call for strategically taking on additional debt. Getting a loan may be difficult when you have several outstanding loans and unsecured credit. But if you are a homeowner, you have something significant of value to use as collateral. Taking out a loan against a home that you are already mortgaging is called taking a second mortgage. The practice is also known as a home equity loan, a term that perhaps more clearly spells out what a second mortgage entails.
What Is a Second Mortgage?
The equity in your home is the market value of the property minus whatever outstanding loan balance exists. You will use that equity as collateral for the loan. If you have paid off a large amount of the mortgage or your property has greatly increased in value, you have a large sum to use as equity and can borrow more. You can be sure that your lending institution will send over an inspector to judge the value of your home up close rather than relying solely on neighborhood data, so if you can afford to make improvements on your home and do a deep clean, you are likely to receive greater equity.
You can extrapolate from this that a good time to try to get a second mortgage is:
- When the property valuations in your neighborhood are high
- When you have large equity in your home
- When you have your home in the best possible condition
When a Second Mortgage Can Help
A second mortgage allows you to borrow large sums of money. If you need to make an investment, if you want to fund a college education, if you want to add a room to your house, a second mortgage can give you the funds to accomplish goals such as these.
Many get a lump sum from their second mortgage in order to use that liquidity for whatever purposes need be.
You can also take out a line of credit based on the home equity. The lender will set a maximum amount that you may borrow. You only take what you need when you need it until you hit that max and you can put the rest back into paying off the loans.
A second mortgage can be useful for a number of situations. For example, if disaster occurs, like a flood or tornado, government assistance and/or insurance may not make you whole. You can use the home equity loan or line of credit to make repairs on your house and replace property you lost.
When a Second Mortgage Can Hurt
In an emergency situation like a disaster, you may have few options and may not give the risk associated with a home equity loan proper consideration. The risks can be minimal, but can also be great.
The greatest risk associated with a second mortgage is the possibility of foreclosure. You can lose your home if you fall behind on payments on the second mortgage. You may wonder what is the difference, since I could also fall behind on payments on the first mortgage? It’s a great question for a financial advisor; however, the answer may depend on the amount of equity in your home and whether the second lien holder (the lender on the second mortgage) wants to wait and see what happens if you fall behind on payments. The second lien holder could force a foreclosure and then buy the first mortgage at auction.
The second mortgage invites initial costs the same as a first mortgage does. You will have a number of fees to pay, an appraisal and credit checks. You may incur expenses if you feel a need to pay off some bills to reduce debt or spend a little to shore up the appearance of your home for the appraisal.
There are both risks and rewards in obtaining a second mortgage. You should discuss any plans to exploit the equity in your home with an experienced financial advisor.
This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.