If you’re a homeowner, your house is more than the physical place you call home—it’s also an asset. In fact, a house represents one of the most valuable assets that many Americans own.
Those assets can be even more valuable, because they can sometimes be used as collateral for a loan.
One example of this is a second mortgage. What is a second mortgage loan? This refers to an additional loan that you can obtain by using your house as collateral while already holding a mortgage secured by your house. Remember that collateral is something that a borrower owns and pledges to give the lender in case they can’t pay back a loan.
An “open-end” second mortgage is an open revolving line of credit that allows you to withdraw money and pay it back up to a maximum approved limit over time, while a “closed-end” second mortgage means you get the entire loan balance at once in one lump sum.
It’s not just called a second mortgage because you took it out in that order. The term also refers to the fact that, if you have trouble paying your mortgage and your home is sold as a result, the proceeds will first go toward paying off your original first mortgage, and only then to any outstanding remaining mortgages (if anything is left) against the home.
Taking out a second mortgage is a big decision, and it can be helpful to know the pros and cons before diving in.
Here’s some information you need to know about this type of loan:
Pros of a Second Mortgage
There are a variety of reasons homeowners may decide to take out a second mortgage. One incentive is that a second mortgage could come with a lower interest rate than some other forms of debt, such as credit cards. Some borrowers therefore may choose to take out a second mortgage to pay off higher-interest debt.
Other homeowners may take out a second mortgage to avoid having to pay private mortgage insurance (PMI).
People generally have to pay PMI, which helps protect the lender if borrowers default on a mortgage, when they make a down payment of less than 20% of the home’s value.
PMI on a conventional mortgage usually costs between (0.35-2.33% ) of the original mortgage amount every year. A “piggyback” second mortgage, which is issued at the same time as the initial home loan, can allow a homeowner to borrow in order to meet that 20% threshold and avoid paying PMI.
Another reason people may take out a second mortgage is to access money needed to fund a major expense. That could be anything from home renovations or medical bills to a wedding or vacation. Since secured loan interest rates are generally lower than for credit cards or certain other unsecured loans, a second mortgage can be an attractive source of financing.
Cons of a Second Mortgage
Second mortgages also come with risks. For one thing, they usually have higher interest rates than first mortgage loans. Higher interest rates mean that the balance you owe can grow more significantly over the life of the loan.
A revolving HELOC “piggyback” second mortgage also often comes with an adjustable interest rate. This means that the interest rate you start out with can increase significantly over time, possibly making it difficult to afford payments.
Another downside is that second mortgages can increase your debt load. There might be good reasons to borrow money, but it also means that you’ll have another monthly payment, likely for a long time going forward. Interest can also add up faster than you expect, especially if your rate isn’t fixed.
If your monthly payments become unaffordable, there’s a lot on the line with a second mortgage: you could lose your home. If saving for your big expense is an option, that will likely cost you less in the long run than borrowing.
You may also want to be wary of paying off short-term, high-interest debt using a second mortgage. That’s because second mortgages generally have longer terms, up to 30 years.
So even if the interest rate is lower than you’re paying on your credit card debt or car loan, the total amount you pay could end up being higher since the interest accrues over a longer period.
Plus, taking out a second mortgage isn’t a breeze just because you already have a mortgage. You might have to jump through similar qualifying hoops in terms of paperwork, fees, home appraisals, and other documents.
Since you can get a second mortgage from any lender, you also might want to put in the work of shopping around for quotes.
How is a Second Mortgage Different From a Home Equity Loan or HELOC?
You may have heard the terms “home equity loan” or “home equity line of credit” (HELOC). If you’re wondering how they differ as second mortgages, they really don’t. Rather, they’re two different kinds of second mortgages.
Some home equity loans allow you to borrow as much as your home is worth, minus what you currently owe on your mortgage. You typically receive the loan as a lump sum with a fixed interest rate that will stay the same over the life of the loan.
A HELOC, as the name suggests, is typically a revolving line of credit rather than a single loan. You can borrow against your credit limit as many times as you want during the “draw period,” which lasts for a certain number of years. If you hit the limit and then repay the loan, you can borrow again.
Once the “draw period” is over, the line of credit shuts down and you have to repay the loans principal and interest over a certain fixed term, sometimes immediately. You may end up being able to borrow less than expected if the value of your home plummets or if your financial situation deteriorates.
Revolving open lines of credit are typically tied to the Prime Rate plus a lenders margin on top of the prime rate. These loans typically come with yearly and life of line interest rate cap.
How Does a Second Mortgage Compare to Refinancing
Like a second mortgage, refinancing your home loan also involves taking out a new loan. However, this new loan replaces your existing mortgage rather than being added on top of your existing loan. People may choose to refinance their homes if doing so gives them access to better financing such as a lower interest rate, a lower monthly payment, and or a fixed rate instead of an adjustable one, or a shorter loan term.
Another reason could be to get access to cash, since you can end up with more in your bank account if you’re paying less in interest or principal each month.
Just like a second mortgage, a refinanced mortgage also uses your home as collateral, so the lender can seize your property if you fail to pay.
Since you’re taking out a new loan, you might be responsible for closing costs, which can include an application fee, appraisal fee, origination fee, and more. You’re more likely to qualify for better mortgage terms if you have a strong credit history and adequate equity in your home.
Refinancing Your Mortgage With SoFi
Whether you’re looking to free up cash or see if you qualify for better loan terms, SoFi makes it easy to apply for a refinance of your home loan. If you qualify based on your loan-to-value ratio, credit history, and other factors, a traditional refinance option may offer you access to better terms such as competitive interest rates.
A cash-out refinance allows you to borrow part of your home’s equity as cash to pay for major expenses like home renovations or high-interest debt. If you have student loans, you could refinance using your home equity to pay off student loans.
SoFi’s mortgage loan officers and financial advisors can guide you through the loan process and help answer any financial questions that may come up.
Before adding on to your debt load with a second mortgage, you may want to consider whether refinancing can help you achieve your goals.
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