What Exactly Is A Second Mortgage?
A mortgage is one of the most popular types of loans available in the economic market, as most homeowners usually can't afford to pay for a home in full with one transaction. However, obtaining a second mortgage on a home you've already purchased is not as commonly known or understood. Taking a second mortgage onto your lengthy list of monthly expenses might seem ridiculous. Still, the loan comes with many benefits you can take advantage of in a dire situation.
Second mortgages can prove useful in many scenarios, but one should know the pros and cons before applying. For example, according to online loan marketplace Lending Tree, they are a viable alternative for homeowners wishing to avoid refinancing their houses. A second mortgage might be the perfect solution for homeowners seeking extra cash for an upcoming life event, but they aren't ideal for everyone. Let's take a look at what secondary mortgages are, how they can affect your financial goals and future, and whether or not these loans are right for you.
What is a second mortgage?
A second mortgage is self-explanatory: A loan a homeowner takes out on a home they've already purchased using an initial mortgage, per Rocket Mortgage. They function similarly to primary mortgages in that the home buyer acquires a loan from a lender and pays the lender monthly until it is paid in full. Second mortgages allow homeowners to tap into their home's equity while still paying off their primary mortgage. An owner's home equity, or the amount the owner has paid toward the home's listed price, differs depending on the home's overall value and how much of the mortgage they've paid off. Homeowners typically access their home equity when they need to get hold of money relatively quickly to pay off a debt.
Lending Tree states that homeowners will take out a second mortgage to pay off credit card bills and college tuition or to fund minor construction projects for the home. According to Rocket Mortgage, second mortgages typically come in two forms: home equity loans and Home Equity Lines of Credit(HELOCs). With a home equity loan, homeowners take out a lump sum of their home's equity at the beginning of the process, paying their lender back monthly as they spend the equity. On the other hand, with HELOCs, the lender offers the homeowner installments of their equity from month to month, giving them monthly limits similar to credit card companies.
Who benefits from second mortgages?
While acquiring a second mortgage can free up a homeowner's money for an emergency, the loans come with their fair share of risks, just like a regular mortgage. Rocket Mortgage states that homeowners take on an extra monthly mortgage payment when applying for a second mortgage, which might be even more challenging to pay off than your primary mortgage. Rocket Mortgage also states that second mortgages generally come with higher interest rates than regular ones. This is because lenders handling second mortgages take on a higher risk doing business with homeowners, as lenders are often left with little collateral in the chance a homeowner falls behind on their monthly payments.
So, those already living paycheck-to-paycheck might not benefit as much from a second mortgage since missing payments could ultimately lead to a homeowner losing their house. Secondary mortgages might also be harmful to those with bad credit. Lending Tree claims many secondary mortgage lenders set a minimum credit score requirement of 620 to use their services, while others set the bar as high as 680. Lending Tree also states that secondary mortgage lenders generally require homeowners to have a lower debt-to-income ratio than primary mortgage lenders since homeowners seeking a second mortgage are taking on greater financial responsibility. Those in good financial standing who can prove on paper that they can afford to tackle two mortgage payments at once will reap the most benefits from secondary mortgages.