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If you are in need of some money to do some home improvements around your home you may want to consider a second mortgage to see what your options are. The second mortgages that are made available to individuals give you the opportunity to draft from the equity in your home for you to use for a few different options.
Depending on your lending institution you will need to find out what their specifications are for lending money for a second mortgage. Some states and lending institutions vary slightly.
In some you have to use the second mortgage money for home improvements or doctor bills that you have acquired and have not been able to pay. This is not true of all states but you will want to check with your banking institution before you make any plans to create a second mortgage.
Overall a second mortgage can be a good option for you if you plan on living in your home for a significant time to have the flexible option of paying it back.
When you must decide to refinance your first mortgage or get a second mortgage, there are some considerations that might help you choose the right course of action. Much depends on your reasons for wanting or needing funds and your future plans for your home. Do you plan on keeping it long term or do you think you'll sell it in a few years? Will you use these new funds for debt consolidation, home improvements, or another purpose? How long have you had your current first mortgage loan and how advantageous are your terms?
If you have had your first mortgage for some time, now seeing your principal finally declining regularly, you may wish to keep this loan intact and use a second mortgage loan to generate the cash you need. Conversely, should your plans dictate keeping your home long term, the best choice might be to refinance your first mortgage to enjoy the rate (which should be lower than the second mortgage rate), the lower payment (since you can spread it over 30 years instead of 10-15 years), and the need to make only one payment to one lender each month.
With good terms on your first mortgage and needing funds for debt consolidation, you might be better choosing a second mortgage. First, the loans or credit card balances you will be eliminating probably have much higher interest rates than you will pay for your second mortgage. Therefore, the ability to spread payments over 10-15 years while enjoying a possibly much lower interest rate, you might benefit from a second mortgage, which will cost less to apply for and close.
The same logic would apply to a need for home improvement funds, particularly if you do not plan to keep the home for the long term. It may be cheaper, faster, and more convenient to just get a second mortgage, knowing that the value of your property should increase since you are spending money to improve it. Conversely, if you plan on keeping your home for the foreseeable future, refinancing your first mortgage, while costing more to close the loan, will save you interest rate cost over time, and require only one monthly payment.
The best advice is to analyze all the factors present in your current financial situation and future plans for your home. If you spend some quality time considering all the pieces of the puzzle, they should finally come together to form the correct picture, showing you the best choice, refinancing your first mortgage or adding a second mortgage to accomplish your goals.
Many second mortgage loans are written with fixed rates, which are normally good for both borrower and lender. However, you have some other choices should you prefer different interest calculations that might work for you. There are a variety of adjustable rate second mortgages (ARM's) that will also serve your needs.
As with all ARM's, you must consider all the components, including the index, margin, adjustment interest rate cap, and lifetime interest rate cap. The components are particularly important with a second mortgage because there are many options that do not have the adjustment and lifetime cap protection that most first mortgage loans include. In fact, many home equity line-of-credit (HELOC) loans can adjust monthly and are tied not to popular first mortgage indices (U.S. Treasury Bill, LIBOR, or 11th District Cost of Funds), but to the U.S. Prime Rate, which can move up quickly in certain market situations. This fact doesn't make a loan tied to the prime rate a poor choice, but you must carefully analyze the overall terms of the loan to determine if it is right for you.
If you choose a HELOC, which is the best choice in many situations, you may not have the option of receiving a fixed rate. Since you control your own loan balance to a great degree, many lenders need the protection of keeping your interest rate at or close to current market since you are using their funds in a current time frame. As always, compare current fixed rates with the future possibilities of any ARM loan you consider to pick the right terms for you.
Second mortgage interest rates are higher than first mortgage rates for the usual reason in the money lending industry: risk. The higher risk of a second mortgage loan versus a first mortgage must have a compensating factor, almost always reflected in the interest rate. Much as a personal unsecured loan has a higher rate than a new auto loan, a second mortgage has less collateral than a first mortgage and projects a much higher cost to collect monies due should the account fall into a delinquent status.
An example of the downside potential of a second mortgage from the lender's prospective might explain. You have a home valued at $250,000. You have a first mortgage of $150,000 and equity of $100,000. You borrow $35,000 through a second mortgage. Your lender earns interest on $35,000, while your first mortgage lender is earning interest on $150,000. You encounter cash flow problems and hour home is to be foreclosed upon. The second mortgage lender, already earning much less than the first mortgage lender, must now “buy out” the first mortgage, spending $150,000 (while earning nothing on this amount since you are in default), to get control of the property, manage it, insure it, and then sell it, hopefully for enough to recover their $35,000, which is now really $185,000 at risk.
This potentially expensive problem dictates that the second mortgage lender has little choice but to charge a higher interest rate on each loan to compensate for this added risk. Usually, the rate differential will not dissuade you from using a second mortgage to consolidate your higher cost debts, make home improvements, or help most other needs for cash.
When you want to do some major home improvements, you have a few choices. You can refinance your first mortgage, borrowing the amount you need for your improvements along with the current balance of the mortgage. The interest rate should be most reasonable and you can choose to repay the balance over 30 years to keep your cash flow reasonable. The downside to this option is the expense of closing a first mortgage, which can easily exceed $1,000, not counting any points involved, which might increase this cost significantly.
A second mortgage or a home equity line-of-credit (HELOC) is often a better, more cost effective option than a first mortgage refinance. If you have created your budget and are confident in the final cost of your improvements, a straight second mortgage allows you to generate the funds you need and for them to be at your disposal quickly. If your project is scheduled to take place over a longer period of time, a HELOC may be a better choice since you will only pay interest on the balance outstanding at each month end. Should the bulk of your home improvements not require payment until some months into the future, you might find a HELOC, which allows you to disburse your loan proceeds (and add to its balance) as you need the money, to be the best choice. This loan type might save you large amounts of interest cost. If done right, your property will increase in value as a result of these improvements so your equity may still be healthy.
While first mortgages come in two basic flavors, 15 and 30 years, second mortgages usually carry terms of 5 to 15 years. The repayment term may be specified by the lender, you may have multiple choices, or the particular loan you choose may require a certain repayment term. Much will depend on the amount borrowed and your debt-to-income ratio. You should select a repayment term that you can comfortably meet per your current cash flow.
If your second mortgage is a home equity line-of-credit (HELOC), repayment terms can be a bit more complicated. Many of these are interest-only loans, so a specific monthly payment, including some principal amount, is often not specified. While you will have the choice of how much, if any, principal will be paid each month, the entire outstanding balance will be due at some point in time, be it 5, 10, or 15 years. Therefore, you should plan how you will repay outstanding amounts before you find yourself in a “balloon” situation, where a large amount is due at the end of your loan term. Should you find yourself facing this situation, shop around for another second mortgage source in time to refinance this loan before the end of your repayment term.
They will both technically be “second mortgages” but they operate differently. The similarities:
The fees and costs to close a second mortgage can be much less than those associated with a first mortgage. Depending on your mortgage lender, you may or may not need a full appraisal. Many second mortgage lenders now will accept a “drive by” appraisal (no interior examination) or even just a recent real estate tax bill showing your property's assessed value. In addition, you should not need a full title examination, only a rundown from the date your first mortgage was recorded. If you shop around, you might even find a second mortgage lender having a “no closing cost special” as they do at times.
The projected costs that you might find:
There are two differences between your second mortgage and your first mortgage. One is legal and the other real world. A second mortgage becomes a second mortgage once it is recorded behind another mortgage, usually behind a secondary market qualified first mortgage. The term “second” does not define a product but a recording “position”. The mortgage recorded after a first is already in place becomes a second by default and definition. If a loan is written as a second mortgage, there will often be different “underwriting” standards from a first mortgage.
Instead of requiring complete documentation for all income, assets, and complicated appraisals, borrowers may be approved for and close loans quickly and easily. Depending on the use of the funds generated by the second mortgage, you might be able to use the interest paid as a tax deduction, which is obviously beneficial. But legally the only difference is the date each mortgage is recorded. The one that is recorded first, by definition, becomes a first mortgage. The next mortgage recorded becomes a second, also by definition.
While the interest rate and time allotted for repayment are usually different, which is probably most important to most of us, there is legally no difference, except for the date of the recording, between a first and a second mortgage loan.
While no one wants to borrow money that is not needed, there are a number of excellent reasons to get a second mortgage loan. If you are a home owner, have equity in your property, and need funds, a 2nd mortgage can be a useful to meet your requirements. Here are some reasons that often make sense:
There is really no difference in the two loans, regardless of what they may be called. Legally, an equity loan could be a first, second, or even third mortgage. However, for a number of reasons, most equity loans are also second mortgages. Here's why.
Most first mortgage loans are sold, or written to be sold, into the “secondary market.” The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) purchase the majority of first mortgage loans so their regulations are the basis for all other buyers, also. There are many built-in protections for both mortgage lenders and borrowers that ensure the validity of both the mortgages and the loans. Equity loans/second mortgages are normally written without many of these protections (title insurance, in-depth title examination, plot plan or survey, etc.) to make giving and getting these loans easy, fast, and at low cost to the borrower. Second mortgage/equity lenders can do this because they have the comfort of knowing that a properly recorded first mortgage is already in place on the subject property. Lenders don't need to duplicate protections that already exist which saves them – and you – money.
It is possible that an equity loan/second mortgage can become a first mortgage in the future. Say you pay off your first mortgage while leaving your equity loan/second mortgage in place. It becomes a first mortgage – since it is the only one recorded – on the day your first mortgage is discharged (paid off). But equity loans will normally only be made if they are in “second position” which by default makes them second mortgage loans.
When you apply for a second mortgage, know the difference between fixed-rate loans and adjustable rate mortgages. If you have a fixed-rate loan, mortgage rates do not change, no matter how many years you pay off the loan. Adjustable rate mortgages, or ARMs, allow for mortgage rates to vary over the life of the loan.
If you apply for an ARM, find out first how the mortgage company changes the interest rates. You want to find out how often the company changes the mortgage rates and its basis for determining rate changes.
Home equity lines are attractive, but there also are pitfalls. That's why you may want to consider a second mortgage. With equity lines, borrowers get a line of credit. Sometimes they tend to spend too freely. Interest rates can vary, and your home is at risk because it is used as collateral.
Take a moment to learn about second mortgage installment loans. They are practical and can make good financial sense. Yes, they are an additional mortgage on your home but the second mortgage is given in a lump sum. You don't get checks to write freely and second mortgages also have fixed interest rates and fixed payment amounts.
A second mortgage, or home equity loan, lets you turn the equity you've put into your home for cash to make home improvements, consolidate debts, or pay for big expenses like your kid's college tuition.
Be aware that some lenders charge a fee for second mortgages. But some states limit the amount, so check with the consumer protection division of your state Attorney General's office, if you have questions. Another resource is the state banking commissioner.
The fee, or point, is usually a percentage of the second mortgage loan amount. One point equals one percent of the loan amount of your second mortgage. Shop around because the number of points lenders charge on second mortgages can vary. Find the best bargain, and get the quote in writing.
When you take out a second mortgage, be sure to ask what your monthly payments will be and what they cover. Some second mortgage loans require you to cover the principal and interest in your monthly payments.
With other second mortgages, your monthly payments may only cover the interest. These second mortgages are known as balloon loans. They work differently: Your monthly payments will not reduce the principal, or loan amount.
So when do you pay back the second mortgage loan? At the end of the loan period. You need to know how you will repay a balloon loan before accept it as your second mortgage, even though the due date is years away.
The life of second mortgage loans may vary. They can be one year, 15 years, or 20 years. Select the repayment terms that fit you and your needs for the second mortgage. If you are borrowing money a large amount of money for home improvements -- say, $50,000 -- you may need a longer repayment period on your home equity loan.
Talk to your lender about how you plan to use the money to find out the terms that you can afford.
|Sheri Ann Richerson|