- 3 min read
- Understand what a second mortgage is.
- Compare Home Equity Loans (HELs) with Home Equity Lines of Credit (HELOCs).
- Use funds from a second mortgage only for important expenditures.
Your Complete Second Mortgage Guide
The term "second mortgage loan" is not frequently used by lenders anymore. The traditional second mortgage is now more commonly called a Home Equity Loan (HEL). A Home Equity Line of Credit (HELOC) is also referred to as a second mortgage. Both loans are secured by the equity in your home, but there are differences between them.
Home Equity Loan
The home equity loan is a traditional second mortgage. Equity is the difference between the current market value and the principal balance of the mortgage loan. A home equity loan uses that difference as collateral for a second loan against your home. It doesn't replace a first mortgage. Because it will be the second debt paid if you default on your loans, it has a higher interest rate than a comparable first mortgage. Most home equity loans have a fixed rate, although some are offered as adjustable rate mortgages. With a HEL, you receive a lump-sum payment in cash and then repay the loan over a fixed period of time.
Home Equity Line of Credit
A home equity line of credit also uses the equity in your home as collateral. Rather than a fixed sum of money, your lender issues you a credit line with a fixed limit. You access the money by writing checks or using a debit card linked to it. HELOCs have a variable interest rate that is based on an index, such as the prime rate, plus a percentage. You may borrow funds any time between the issuance of the credit limit and its expiration date, which can be anywhere from three to twenty-five years. Your repayment terms and amounts vary, depending on the amount borrowed and current interest rat you are paying. Many HELOCs require you to remove an initial sum and not repay it until the line of credit expires. Many also require a minimum withdrawal each time you access the funds.
How to Use a Second Mortgage
Regardless of which type of second mortgage loan you choose, second mortgages should primarily be used to:
- Make home repairs
- Remodel your home
- Pay education expenses for you or your child
- Reduce other debts
- Pay medical expenses
- Pay emergency expenses
In other words, a second mortgage should be used to improve your child's or your financial future. You should be very cautious about using it for investments or purchases of consumer goods like televisions, cars, boats, or other big-ticket items.
Any time that you borrow from your home equity, thereby reducing your equity stake, there are risks involved. For instance, if your home drops in value after you have borrowed against a high percentage of your home's value, you may not be able to sell it for more than you owe. This can trap you in your home, unless you have enough money set aside to pay off your lenders at the time of sale.
Second Mortgage Right of Rescission
You have three business days, not including Saturdays, Sundays, and legal holidays, from the date you sign your home equity loan documents to cancel the loan without cost to you. The loan must be against your primary residence. If you used the same lender as your original loan, then you only qualify for rescission if you increased the amount of your original loan with a cash-out refinance or took out a home equity loan. You can rescind any mortgage refinance or home equity loan within the three day period if you used a different lender.
Like any financial product, a second mortgage is neither a good or bad thing on its own. The key is what will it do for you, what will it cost you, and are the potential risks you take outweighed by the benefits that come your way. Take your time and weigh all the factors, before making any major financial decision.