A second mortgage is something that many people take out. This does not mean that two mortgages are needed to pay for the house. Instead, what it means is that a person borrows a significant amount of money and uses their home’s equity or value as collateral. This cash flow can really help a person do everything from improve the property to improve its value to fund an education. However, a second mortgage does not come for free. Instead, one will have to pay interest rates and fees associated with the loan. The following includes some basic information about second mortgages and how they work.
How is Equity Calculated?
Equity is how much your house is worth. Of course, it is much more than this. Really, equity is calculated by taking the amount of the unpaid mortgage as well as any other debts associated to the property and subtracting it against the market value of the home. The more a person pays on a home loan or the more value the house takes on over the years, the more equity a person has to work with. Thus, if a person has a property worth $100, 000 and still owes $60,000 on the mortgage, then this individual would have $40,000 worth of equity with which to work.
A person’s first or initial mortgage is always most important. For example, if one is defaulting on their loans, then the person is expected to catch up or pay the balance on the first loan before tackling the second one. Additionally having a second mortgage means balancing two mortgage payments and thus two interest rates.
Benefits of a Second Mortgage
The main benefit of a second mortgage is cash flow. Borrowing against a home means that a person can borrow more money at a lower interest rate. The following are just some of the many projects a person could fund with such money:
Remodeling Projects
Adding a room or floor to a home or improving the bathroom could improve one’s life and could also increase the market value of the home. This means that a homeowner could make an important investment that could reap some serious returns if he or she decided to sell this home in the future.
Pay Off Old Debts
Sometimes, paying off old credit card bills and debts can take a long time. Using a second mortgage to pay off such bills could increase one’s credit score and help a person secure a solid financial future.
Start a Business
One of the safest way to earn seed money for a business or project is to invest in a second mortgage. However, one should always calculate the risks involved with such a venture before borrowing against a home. After all, a failed business could mean little income which in turn could result in a person defaulting on both mortgages and losing the property.
Pay for School
A college education is not cheap. Some parents and individuals are willing to borrow against their home if a degree is on the line.
Large Purchases
Purchasing another property or an expensive new item. A second mortgage could be used to purchase an apartment complex, summer home, or new property. Additionally, if it’s time to get a new car, these funds could provide an individual with a low interest form of funding.
Second Mortgage Rates and Fees
There is some risk involved with a second mortgage. This is why one can expect higher interest rates than with the first loan. After all, this is another bill to pay. If the homeowner defaults on the loans, the first mortgage will be paid off before the second. Thus, the financial organization issuing this second mortgage will want to protect itself with higher interest rates. Additionally, the duration of the second mortgage will be shorter than the first loan. This is because this loan is usually smaller than the initial mortgage. The quote a person receives will be based on the individual’s credit score, economy, and the loan to value ratio (i.e. amount of equity a person has to work with).
Applying for a Second Mortgage
One does not have to gain the second mortgage from the same place as the initial home loan. Instead, homeowners should shop around to see where they can find the best interest rates, fees, terms, and quotes. Again, it is important to note that any second mortgage will most likely contain slightly higher rates than the first loan. Interested lenders will want an appraisal of the home to determine its value. This is to protect the lending organization in the event that the borrower falls behind on loan payments. Closing costs to the second mortgage are common, just like with the first loan.
Know One’s Limits
Just because a person has equity does not mean that he or she should take on second mortgage. After all, this is not free money: It is a loan that has to be paid back. Thus, if a person has $40,000 in equity, he or she needs to be smart about how much is borrowed. After all, the monthly payments need to be in line with one’s monthly budget. It makes no sense to take on a second mortgage if a person can barely pay his or her first home loan each month. Thus, one should consider the following things:
- If they really need to take out this second mortgage (i.e. can this project wait until a person is more financially secure).
- If the project is worth this investment (i.e. starting a business may be a great idea, but if done poorly, a person could lose the money they invested in this project).
- One’s monthly budget (i.e. can one add another monthly bill to his or her plate and is a person’s income steady and reliable enough to take on such an expense).
- What does the economy look like (i.e. if the housing market is on a downward swing or the economy is not stable, it may be best to wait until conditions are more favorable: the lower the interest rates, the more money a person will save each month and in the long run).
A second mortgage is a smart investment for people who have a sizable amount of equity, a steady source of income, a competitive credit rating, and a project or need for cash flow. This is a smart way to free up a large sum of money. After all, a home is often the most valuable thing a person owns. This is why it is important to research second mortgage rates. The lower these rates, the more money a person will save when it comes to securing this type of home loan. People should be sure that they can handle a second loan before applying and agreeing to one. This means making a budget, figuring out how much money a person has to work with each month, and whether or not the home loan is a reality. If it is, then people can apply for thousands of dollars that could be used for a renovation or remodeling project, to start a small business, pay for a college degree, or some other big purchase or project.
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