Do you have growing equity in your home? If so, you may want to pull out some of that cash to remodel your kitchen, pay off debt, or fund your child’s college tuition.
You can tap your equity with a mortgage refinance or a second mortgage. If you already have a low-interest rate on your first mortgage, consider getting a second mortgage.
Learn more below about your options with a second mortgage, home equity loan, and other alternatives.
What Is a Second Mortgage?
A second mortgage is another loan taken against your home that already has a mortgage. Homeowners often take out second mortgages to fund big purchases, such as home renovations, paying off debt, or funding college tuition.
There are two types of second mortgages that you can choose to access some of your home equity.
Home Equity Loan
- A home equity loan is a fixed-rate, lump-sum loan with a term ranging from five to 30 years. The homeowner pays back the loan in fixed payments each month until the loan is paid off.
- A home equity loan might be a good choice for you to fund a one-time major expense, such as buying a second home or paying down credit cards.
- Home equity loans have fixed rates and the payments are locked in for the life of the loan, which makes your budgeting easier.
- Your home secures the home equity loan, so you risk losing the property if you do not pay.
Home Equity Line of Credit (HELOC)
- A home equity line of credit is another type of second mortgage. It has a variable interest rate and a credit line that you can draw from when you need it.
- A HELOC typically features a draw period of 10 years with interest-only payments during this time. After the draw period ends, you repay both principal and interest.
- Minimum monthly payments are based on a variable interest rate. You can use the funds again as you pay off the credit line.
- Homeowners may choose a HELOC if they anticipate making periodic payments for a home remodel or college tuition.
- Some homeowners also like to have a line of credit available for financial emergencies. However, if your credit slips or you lose your job, your lender could reduce your credit line or even close it.
How a Second Mortgage Is Calculated
Lenders usually only allow you to take out a certain portion of your home equity. How much you can get depends on the home’s value and how much you owe on your first mortgage.
Most mortgage lenders allow you to take out up to 80% or 85% of your home’s value.
To determine how much money you can get, add how much you want to borrow to what you owe on your first mortgage. Divide that sum by your home’s current appraised value. That gives you your loan to value or LTV.
For example, if your home is worth $300,000 and you owe $200,000 on your first mortgage, you have $100,000 of equity.
Most lenders will allow you to borrow up to $80,000 or $85,000 of your available equity. Taking out a second mortgage would give you a new loan balance of approximately $280,000.
Are Rates for Second Mortgages Higher Than First Mortgages?
Generally, second mortgage interest rates are higher. The mortgage lender is taking a bigger risk with a second mortgage.
If you qualify for the second mortgage, the lender puts a new lien on the home. The second lien holder gets paid second in the event of a foreclosure. So, the rates for second mortgages reflect that higher risk.
Still, rates for second mortgages are generally much lower than for personal loans or credit cards.
When Is a Second Mortgage A Good Idea?
Taking out a second mortgage may be right for you if you have a big expense but already have a low rate on your first mortgage. Most mortgage experts only recommend refinancing a first mortgage if you can save at least .5% on your rate.
Getting a home equity loan or HELOC also can be a great move if you want money for something that has a solid return. Examples are a home improvement, a college education, or buying an investment property.
Second mortgages also can be used to pay off high-interest credit card debt, but beware of running up those credit cards again!
The mortgage interest on a second mortgage is tax-deductible IF you are using it to make a major improvement to your home. Examples are a kitchen or bath remodel, adding a swimming pool, or family room addition.
Should You Get a Home Equity Loan or HELOC?
What is your risk tolerance? A home equity loan has a fixed interest rate and set payments for the life of the loan. People who like more financial certainty may prefer a home equity loan.
On the other hand, a home equity line of credit has a lower interest rate at first. But the rate can rise considerably in the future. If you can sleep at night with this uncertainty, a HELOC could work for you.
Also consider if you need a big sum of money right now, or funds periodically over time. A home equity loan gives you all your available equity immediately, and you pay interest on all of it from day one.
A HELOC provides funds to you as you need them, and you only pay interest on what you use.
Home equity loans and HELOCs are different types of second mortgages. Both pull equity from your home that you can use for cash purchases.
Home equity loans are fixed-rate, while HELOCs are variable rate.
Second mortgages may be the right choice for low-interest funds when your first mortgage rate is low and refinancing is out of the question. Talk to your mortgage lender to see if a home equity loan or HELOC is appropriate for your financial needs.
- Home Equity and HELOC Differences. Retrieved from https://www.investopedia.com/mortgage/heloc/differences/
- Second Mortgages vs. Home Equity Loans. Retrieved from https://www.usbank.com/home-loans/home-equity/second-mortgage-vs-home-equity-loan.html
- How Does a Home Equity Line of Credit Differ from a Second Mortgage? Retrieved from https://www.thebalance.com/home-equity-second-mortgage-2386160