When buying a house people take out a mortgage loan, which allows them to pay for their house, and uses the house as collateral. As that loan gets paid down, a second mortgage can eventually be taken out on the house, which would use the equity that has been built up over time.
As with the first mortgage, the second mortgage also uses the house as collateral, so if ever the owner defaults on their payments, the house could be repossessed in order to pay the loan.
1. Borrow more
Because a second mortgage has collateral, it is usually possible to get higher sums of money. Unsecured loans, those are loans that don’t have any kind of collateral backing them up, are often smaller because the lender can’t be sure that it will receive that money back if the owner ever stops making payments.
Lenders are willing to lend out higher sums of money when they know that the house will ultimately pay the debts if ever it comes to that. Lenders will allow homeowners to borrow up to 80 per cent of their home’s value, split between the primary and second mortgage.
2. Why borrow
It isn’t recommended to take out a second mortgage in order to go crazy and spend it all for fun. Second mortgages are ideal for achieving goals and moving forward. For instance, many people use second mortgages to renovate their homes.
Others use them to consolidate their debts, since second mortgages often have lower interest rates than unsecured consumer debts like credit cards. Still others will use the second mortgage to pay for higher education. Whatever the reason, the most important thing to remember is only to borrow what is manageable to pay back because the house is literally on the line.
3. What borrowers get
Borrowers can take a second mortgage in a variety of ways. Firstly, they can receive a lump sum of cash which would be paid over a set period of time via equalized payments. Alternatively, borrowers can use a line of credit option.
With the line of credit method, the borrower is basically given space to spend from. So, if they are allowed $50,000, for example, they can borrow and pay back any amount, as long as it does not surpass their $50,000 limit. Much like credit card debt, it is revolving so it can be borrowed and paid back multiple times.
4. Shop around
An important note for people looking to take out a second mortgage on their home is that homeowners should always shop around for the best rates. There are many different types of lenders, including banks, credit unions, mortgage brokers, and online lenders.
Each one may have good rates or good options for borrowers, and there is no single go-to lender that is always best. Not only will shopping around allow borrowers to find the best deal, but it will help keep them informed about what normal rates are, and what kinds of offers are available.
5. What it means for lenders
Because a second mortgage comes after the primary mortgage, they are actually riskier for the lenders. If the borrower were to ever default on their payments, the lender of the first mortgage would be paid back first, in full, before the lender of the second mortgage would receive anything.
This is why the interest rates for second mortgages, although lower than other types of debt, are actually slightly higher than the interest rates for primary mortgages. This is also the reason that lenders only allow borrowers to take loans against a certain percentage of their house, to try to avoid the possibility of losing money.