If you have built up enough equity in your home, you might be in a position to qualify for a second mortgage. In short, a second mortgage is a new loan that you can take out on a home that already has a mortgage. Also known as a junior loan, a second mortgage does not replace your first mortgage, and you must have equity in your home to qualify for a second mortgage. The amount of equity in your home determines the loan amount you can qualify for on a second mortgage.
Types of Second Mortgages
Home equity loans and home equity lines of credit are the two most frequently used second mortgages. A home equity loan allows you to borrow a fixed amount of money based on your home’s equity, and you receive that money from your lender in one lump-sum payment. You pay back the loan over a fixed amount of time just like you do with your first mortgage. Home equity lines of credit, known as HELOCs, work just like credit cards where you pay your outstanding balance each month and replenish your available credit. The maximum available credit line on a HELOC is the amount of equity in your home.
When to Use a Second Mortgage
At some point, you may have heard someone jokingly say that they need to take out a second mortgage to pay for something like a new computer or designer clothes. Obviously, buying luxury items with a second mortgage is not the best financial decision. However, there are times when taking out a second mortgage is a sound financial decision. Here are some common reasons why homeowners take out second mortgages:
- Eliminating high-interest credit card debt
- Financing home improvement projects that increase the value of the home
- Paying for a child’s college tuition
However, you must remember that taking on a second mortgage means that you are adding to your debt burden. You must make the monthly payment on a second mortgage just like you would a first mortgage. Additionally, if you fail to make the payments on your second mortgage, your lender will start foreclosure proceedings, even if you no longer owe money on your first mortgage. You should never impulsively approach a second mortgage just because you have built up substantial equity in your home. Remember that any kind of debt, including second mortgages, can have a tremendous effect on your financial future.