Nearly half of American homeowners who take out a mortgage are considered “equity rich.”
Second-quarter data from real estate data firm ATTOM shows that 48.1% of homes with mortgages or other mortgages cover at least half of their value as home prices have skyrocketed over the past few years. .
“After 124 straight months of rising home prices, it’s no surprise that the share of equity-rich homes is at an all-time high and the share of severely underfunded loans is the lowest ever.” ATTOM’s Market Intelligence said in a report.
In other words, many mortgage holders are well-positioned because they hold record-high accessible equity.
The opportunity to borrow against this equity is readily available to many. Many also consider using a Second Her Mortgage, Home Her Equity Her Loan, or HELOC to finance a home renovation, pay for a child’s college education, or debt consolidation. . Understanding the nuances of a home equity loan or her HELOCs and what it means to have a second mortgage can help you make informed borrowing decisions.
What is a second mortgage?
“The second mortgage is a lien on your property behind the first mortgage,” explains Tabitha Mazzarra, director of operations at Mortgage Bank of California.
A second mortgage does not replace your existing mortgage. This is an additional loan that you borrow and repay separately from the mortgage you used to buy the house, with the house acting as collateral for the new loan.
The term “second mortgage” refers to how a loan is handled in the event of foreclosure. If the payments are overdue and the house is foreclosed on, the house is sold to pay off the debt. From the proceeds of the sale, the first mortgage (the mortgage used to purchase the home) is first satisfied. Any remaining balance will be applied to the second mortgage.
If you don’t have enough capital to pay off both loans, the second mortgage lender may not receive the full amount owed. Due to the risk of not being repaid in full, lenders typically charge a higher interest rate on a second mortgage than on a primary mortgage.
Two common forms of second mortgages are home equity loans and home equity lines of credit (HELOC).
What is a Home Equity Loan?
A home equity loan is a type of loan that is taken against the equity set up in a home.
“In today’s climate, [taking out a home equity loan] It’s advantageous if someone has a higher interest rate on their first mortgage, because the second mortgage can be used to withdraw cash for home improvement or to pay off existing debt. A second mortgage is a good option if you don’t want to get in the way of a second mortgage.”
According to Sarah Catherine Gutierrez, certified financial planner and CEO of Aptus Financial, home equity loans can have higher interest rates than other forms of credit.
“They usually have lower interest rates than personal loans or credit cards because your home is the collateral,” she said.
As of August 4, 2022, the average home equity loan interest rate was 6.38%. By comparison, the average annualized rate (APR) for interest-rated credit cards was 16.17% and the average APR for personal loans was 9.41%. %.
Common uses for home equity loans include:
Is there a difference between a second mortgage and a home equity loan?
The terms “second mortgage” and “home equity loan” are often used interchangeably, but they are quite different.
The term “second mortgage” refers to the type of loan and the position of the loan relative to the primary mortgage. A home equity loan is a form of second mortgage, but if your mortgage is gone and you own your home outright, you can also get a home equity loan.
“If you own an unencumbered home, a home equity loan or line of credit is preferred,” Mazzara said.
When purchasing a second mortgage or home equity loan, ask for a quote within a limited period of time, such as 30 days, to minimize the impact on your credit score.
Pros and Cons of a Home Equity Loan as a Second Mortgage
A second mortgage or home equity loan usually gives you access to a large amount of cash for your goals. Especially if you have a substantial amount of money in your home.
Because second mortgages and home equity loans are collateralized by the home, interest rates are usually lower than other options. And with a repayment term of 20+ years, it makes payments easier to manage. As an added bonus, the interest paid on the loan may be tax deductible if you use the money on qualifying home repairs.
However, a second mortgage or home equity loan isn’t for everyone.
“they [second mortgages] It can be very risky for several reasons,” warns Gutierrez.
Unlike personal loans, home equity loans take a long time to process, so they may not always help you in the event of an unexpected and urgent expense. Also, depending on the lender, you may have to pay closing costs (which can cost thousands of dollars) to get a second mortgage.
For the risk averse, using a home as collateral can be too risky as late payments can result in foreclosure. With more debt, it will take longer to pay off your mortgage.
“But in general, why would you want to keep building up your mortgage for more years?” Gutierrez asked. “Housing benefits make it harder to quit your job, especially now that you’re approaching retirement age. Don’t add a burden to a task that already seems impossible.”
You may be able to get large loans
Second mortgages typically have lower interest rates than other forms of credit
Second mortgages and home equity loans have longer repayment terms than other options
May be tax deductible
Risk of losing your home in foreclosure
Rebuilding equity can take a long time
Second mortgages and home equity loans can take weeks to process
you may incur closing costs
Home Equity Loan vs HELOC
Home equity loans are what most people think of when they think of a second mortgage, but there is another option: a HELOC.
Similar to a home equity loan, a HELOC allows you to borrow against established equity in your home. However, a home equity loan is a lump sum cash he can avail for one time while a HELOC is a type of revolving credit.
“HELOCs provide a line of credit that can be used,” Gutierrez said. “There are also a few of his HELOCs with fixed rates, but they tend to be floating rate. You are operating under this contract and can withdraw your money when you need it.”
During the HELOC lottery period (often 10 years), the HELOC can be used repeatedly up to the approved limit, making it a good option to spend without a fixed cost or to have as a backup safety net.
After the lottery period ends, HELOCs will enter a payback period of 5 to 20 years. HELOCs typically have variable interest rates rather than fixed rates, so interest rates can fluctuate significantly. However, you only pay interest on the funds you use.
HELOCs are attractive, but be aware that their availability may be limited if the economy deteriorates, banks tighten access to credit, or assets dwindle. Because it may not be accessible when you need it, Gutierrez says it is not a reliable source of funding for unexpected expenses and should not be a substitute for emergency funding.
“Imagine: If your home’s value goes down…you’re out of options. [for emergencies]’ said Gutierrez.
Second Mortgage vs Home Equity Loan vs HELOC: Which Is Better For You?
If you are considering taking out a second mortgage and are considering a Home Equity Loan or HELOC, carefully weigh the pros and cons. Whether it’s a good idea depends on several factors, including your overall financial situation, your intended use of the second mortgage, and whether you need access to ongoing credit.
Review all financing options before applying for a second mortgage such as a home equity loan or HELOC. Sometimes it’s better to save money for a few months than to take out a loan or line of credit.
“I think people should work on their cash management system, save for planned expenses and unforeseen emergencies, and use home equity when needed,” Gutierrez said. “I think home equity is a good second line of defense.”
If you decide to borrow against equity, request quotes from multiple home equity lenders to find the best terms and rates available.
How home equity is calculated
The amount you can borrow depends on your income, credit, and current home value. Generally, the maximum amount you can borrow is up to 80% of your available assets, or the current value of your home minus the amount you owe on your mortgage, known as the loan value ratio (LTV). increase.
To find out how much you can borrow, follow these steps:
- Identify the current value of your home. Popular sites such as Zillow and Redfin have home price estimators. Experts warn they aren’t the most accurate, but they can give rough figures.
For this example, let’s say the house is worth $400,000.
- Determine your mortgage balance.
For this example, let’s say you have $200,000 left on your loan.
- Calculate how much equity you’re dealing with by subtracting the balance from the home’s value.
$400,000 – $200,000 = $200,000. (50% stake).
- Find out the maximum percentage of house value (maximum LTV) that a lender will allow to rent.
For example, some lenders offer up to 80% LTV, while others offer up to 90% LTV. This example uses an LTV of 80%.
- Multiply your home’s current value by the maximum LTV%
$400,000 x 0.80 (80%)=$320,000
- Subtract your loan balance to get the maximum amount you can borrow.
$320,000 – $200,000 = $120,000
|Home current price||$400,000|
|home equity quote||$200,000 (50% stake)|
|LTV ratio (before home equity loan)||50%|
|Maximum LTV from lenders (including home equity loans)||80%|
|Maximum borrowing amount (0.80 x $400,000)||320,000|
Based on this example, a homeowner can borrow up to $120,000 in a home equity loan or HELOC. As you can see, home equity loans can give you access to much more cash than other financing options such as personal loans.