Years ago, second mortgages were all the rage; with the appeal of gaining access to extra cash, it’s obvious why that was the case. But then the recession hit, leaving millions of homeowners with an unfit match of high mortgage payments and reduced income. Not a fun time. However, now that the economy is slowly picking itself back up, you may be wondering if it’s a better time to take out a second mortgage.
Before you make that decision, it’s important to understand exactly what a second mortgage is and what it would mean for you.
A second mortgage is an additional mortgage on your home; in other words, it’s a loan that’s secured against your house. The fact that it is “second” means that if you were to default on your house, your first (or primary) mortgage must be paid off before anything goes towards the second one.
There are two types of second mortgages: home equity loans and lines of credit. If you take out a second mortgage as a loan, you’ll receive a lump sum of money based on the equity in the home. Essentially, equity is the difference between the balance of the original mortgage and the value of your home. (A house valued at $350,000 and a mortgage balance of $300,000 means you have $50,000 in home equity). If you take out a loan, you must repay the money in installments over a set period of time.
Under a line of credit, your second mortgage will work similar to a credit card. This means that you’ll have a credit limit that can be reused as you pay the balance. The amount of money you have access to depends on the equity in your home and how much the bank is willing to lend you.
Why would a person need to take out a second mortgage in the first place? Typically it’s because they either a) Need extra money or b) Want to buy a house. Here’s what that might look like for each.
If the value of your house has risen, you might want to take a cash-out second mortgage so you have extra spending money that can be used for anything—college tuition, home renovations, that dream European vacation, etc.
Or, if you want to buy a house and your primary mortgage lender won’t lend as much money as you’d like—meaning you’d have to make a significantly larger down payment than you were planning— a second mortgage might come in handy.
Both sound like great reasons to take out a second mortgage, but it’s not for everyone. In some cases, you might end up with a higher rate and get charged with significant fees for taking out a second mortgage. Additionally—and most importantly—there’s a lot of risk involved. Since a second mortgage is taken out against your house, there’s a chance you could lose the house if you can’t pay the loan.
So, if you want to take out a second mortgage, make sure your reasons justify the additional costs and risk involved.
If you’re not sure taking out a second mortgage is right for you, but are in a tight financial situation, meet with a financial advisor to see if there are any alternative solutions. For example, you might be able to refinance your home or build up your savings with a new financial budget.
Either way, take the time to figure out what’s best for you and your family.