A second mortgage can be a useful financial tool

This phrase might seem a little odd: “A second mortgage?” If you already have one loan, why would anyone want another?

Second mortgages, also known as home equity loans, can help you achieve other financial goals. It may be worthwhile to consider a second mortgage in these times of historically low interest rates and rapidly rising home equity.

What is a second mortgage and how does it work?

People often refer to “second mortgage” as a home equity loan, or home equity credit line (HELOC).

Matthew Stratman is the lead financial advisor at California’s South Bay Planning Group. He says that a second mortgage is essentially a loan on your home that takes a second place after your primary mortgage.

Home equity loans or HELOCs are second mortgages that homeowners who have enough equity can borrow against. Your equity is calculated by subtracting the remaining loan amount from your total home value.

Types of second mortgages

There are two types of second mortgages available: a home equity loan and a home equity credit line (HELOC). A home equity loan allows for you to borrow one lump sum at a time. A HELOC, on the other hand, functions more like a credit-card. You can spend the amount up or down, and only pay what you use.

This is a detailed explanation of each type of second loan.

Home Equity Loan

The home equity loan is similar to your primary mortgage. You will need to give the lender all your financial information in order to be eligible for one. The lender will evaluate the value of your house and determine how much home equity loan you are eligible for. You can then take out the money in a lump sum, which you would pay back over a period of 20 or 30 years with interest.

Stratman says that one of the greatest benefits of home equity loans is the low interest rates. Mortgage lending rates are generally lower than personal loans and credit cards. Home equity loans are a great option for home renovations that don’t require a large upfront payment but can potentially increase the value of your home.

Stratman states that the best way to make use of equity in your home is if it’s being used as a future asset to your property.

HELOC

HELOCs are a type of revolving credit that works in the same way as a credit card. A HELOC would be applied for in the same manner as a home equity loan. The lender would set a maximum amount you could spend. The credit limit you have will be limited to 85% of the value of your home or less. When determining your limit, lenders take into account your credit history as well as income factors.

You can spend as much as you like during the “draw period.” After the draw period ends, you will have to pay back any amount that you used.

Stratman states that a home equity credit line is a good option if you need the ability to access it. However, you may not be able to predict when you will need it.

For example, if there is an emergency roof leak, HELOCs could be a great option. They can also be useful for planning larger home renovations.

Hall states that home equity lines of credit can be a positive option when you are doing a project like a remodel. You may need different amounts of cash throughout the process.

The Second Mortgage vs. Refinance

Refinancing your home is another popular way to manage major expenses and strengthen your financial base. Refinancing and second mortgages are two different things. Both can help you save interest in different ways.

Refinance is when your primary mortgage is essentially refinanced — usually with a lower interest rate and better terms. A second mortgage by arbitration is different. This means that you don’t save interest on your principal mortgage. Instead, you can use the money borrowed from the second loan to pay off high-interest debts or purchase something you wouldn’t have bought if you had a high-interest credit score.

You may be able to access a cash out refinance. This allows you to take advantage of the equity in your home and receive a lump sum.

What are the best times to consider a second mortgage?

Stratman suggests that major home renovations are a good time to think about a second mortgage. You can make investments in your home, such as adding a kitchen or a bedroom. These are good uses of your home equity and will increase your home’s value.

To prepare for unexpected housing expenses, you might consider a home equity credit. Older homes may have leaky roofs and old heating systems that could lead to expensive repairs. A HELOC can be a way to pay it off with a lower interest rate than a personal loan or credit card.

Hall states, “It truly does offer peace of heart.”

However, home investments are not the only reason to think about a second mortgage. Stratman states that debt consolidation is one way people can make use of it wisely.

Here’s how it might work: Imagine you have $15,000 in credit card debt with an 18% rate of interest. A second mortgage would allow you to pay off your credit card with money borrowed from your bank. This would result in a lower interest rate and save you money over the long-term.

Stratman and Hall both said that there are some situations when you shouldn’t use a second mortgage. A second mortgage is not a good idea if you have difficulty managing your finances or are struggling to pay your bills. You shouldn’t spend the money on a lifestyle purchase, such as a boat or a luxury car.

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The main point is to make sure you use the money as productively as possible. Don’t let equity money finance your lifestyle. Stratman states that if it is responsibly used, it could be a good idea.