Pros and Cons for Having A 2nd Mortgage
Did you know you could have access to the equity you built on your home without having to sell the house itself? By taking a second mortgage, you could have access to a large sum of cash while still enjoying your home. There are two kinds of second mortgages:
- When taking an equity loan on your home, you will have access to a lump sum of money usually financed by a fixed rate loan: you will repay a set amount of money every month
- When taking a home equity line of credit (also called HELOC), you will basically use your loan like a credit card: your lender will decide on a maximum borrowing limit, and you can borrow as much or as little as you want within these limits over time. This type of loan generally has a variable rate.
Although having access to this cash can be an attractive idea, there are pros and cons to a second mortgage you will need to keep in mind before taking that decision.
- Quick access to a large sum of cash at a favorable rate: a lender will usually approve you to borrow 75 to 85 percent of the loan-to-value ratio of your first and second mortgages combined. Several factors like your credit score will determine your interest rate, but they are usually significantly lower than the ones you would get for a credit card. However, keep in mind that the interest rate on your second mortgage is likely to be higher than the one on your first mortgage since the second lender is taking more risk.
- Your loan payment might be tax deductible: consult your tax adviser to check is the interest paid on your second mortgage might be tax deductible
- Use the money to improve your equity on your house: a common use for the money obtained from a second mortgage is to improve your home, by either renovating it or adding elements like a deck or an addition. Either way, you are adding to the value of your home. You could also use the money to consolidate your debt, avoiding the high interests on your credit card debt
- You could lose your home: since you are using your house as collateral, you would lose your house to foreclosure if you were to default on your payments. Choose what you spend your money on wisely and don’t overextend yourself. For example, funding your lifestyle or spending it on frivolous items, like a luxury vacation, could put you in a difficult spot
- There are significant fees to getting a second mortgage: like for first mortgages, second mortgages (a home equity loan in particular) comes at a cost. You will have to pay for an appraisal, closing costs, application fees and so on. For a home equity loan, count between 3 and 6% of the total loan amount in closing fees. Although there are no closing fees for a HELOC, the interest rates tend to be higher, and you will pay more in the long run.
Although acquiring a second mortgage can sometimes be a great idea, consider carefully which type of second mortgage makes the most sense for you, and, most importantly, what you will be spending this money on.