What is a second mortgage?

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If you’re a homeowner, your house is not only the place you call home but also an asset. In fact, it’s the largest asset of most Americans, according to the most recent Federal Reserve Survey of Consumer Finances. That asset can be even more valuable because it can sometimes be used as collateral for a loan, such as a second mortgage.

 

Related: What is a reverse mortgage?

How Does a Second Mortgage Work?

A second mortgage is 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 borrowers own and pledge 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, as needed, up to a maximum approved limit, over time. A “closed-end” second mortgage is a loan disbursed in a 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 can’t make your mortgage payments and your home is sold as a result, the proceeds will go toward paying off your first mortgage and then toward any remaining mortgages (if anything is left) against the home.

Types of Second Mortgages

We just alluded to home equity loans and home equity lines of credit (HELOCs). Here are the details.

1. Home Equity Loan

Home equity loans are generally limited to 85% of the equity in a home, with the exact amount influenced by income, credit history and current market value. You’ll receive a lump sum with a fixed interest rate that will stay the same over the life of the loan. Terms may range from five to 30 years.

2. Home Equity Line of Credit

As home values spiked, HELOCs became more difficult to get. If you can find one, here’s how they work.

 

Again, you may be able to borrow up to 85% of the appraised value of your home, less the amount owed on the first mortgage, depending on your creditworthiness. Because a HELOC is a revolving line of credit rather than a single loan, you can borrow against the credit limit as many times as you want during the draw period, often 10 years.  During the draw period, payments are usually interest-only on the amount withdrawn. After that, you must begin repaying principal and interest on whatever amount you borrowed for the remainder of the term, often 20 years.

 

Most HELOCs have a variable interest rate that’s tied to the prime rate — an interest rate determined by individual banks — plus a lender’s margin. They typically come with yearly and lifetime interest rate caps.

Pros and Cons of a Second Mortgage

Taking out a second mortgage is a big decision, and it can be helpful to know the advantages and potential downsides before diving in.

Pros of a Second Mortgage

  1. Relatively low-interest rate. A second mortgage may come with a lower interest rate than debt not secured by collateral, such as credit cards. Some borrowers, therefore, choose to take out a second mortgage to pay off high-interest debt.
  2. PMI avoidance via piggyback. A homebuyer may take out a second mortgage to avoid having to pay private mortgage insurance (PMI). People generally have to pay PMI when they make a down payment of less than 20% of the home’s value. PMI helps protect the lender if borrowers default on a mortgage. But it can add up. Most borrowers pay from $30 to $70 a month in PMI for every $100,000 borrowed, Freddie Mac says. A “piggyback” second mortgage can be issued at the same time as the initial home loan and allow a buyer to borrow in order to meet the 20% threshold and avoid paying PMI.
  3. Money for a big expense. People may take out a second mortgage to access funds needed to pay for a major expense, from home renovations to medical bills to a wedding.

Cons of a Second Mortgage

  1. Potential closing costs and fees. Closing costs come with a home equity loan or HELOC, but some lenders will reduce or waive them if you meet certain conditions. With a HELOC, for example, some lenders will skip closing costs if you keep the credit line open for three years. It’s a good idea to scrutinize lender offers for fees and penalties and compare the annual percentage rate, or APR, not just interest rate.
  2. Rate issues. Second mortgages generally have higher interest rates than first mortgage loans. And a revolving HELOC “piggyback” second mortgage likely comes with an adjustable interest rate. This means the rate you start out with can increase — or decrease — over time, making payments unpredictable and possibly difficult to afford.
  3. Risk. 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 money.
  4. Must qualify. Taking out a second mortgage isn’t a breeze just because you already have a mortgage. You’ll probably have to jump through similar qualifying hoops in terms of paperwork, home appraisal and other documentation.

How Does Home Equity Work?

Your home equity is the market value of your home, minus anything still owed. The more equity you have in your home, the more money that will be available to you should you decide to take out a second mortgage. There are a few key ways to build equity:

  1. Pay your mortgage. With each principal payment you make, that much more is added to the overall equity of your home.
  2. Make home improvements. Installing a new roof or remodeling a kitchen can increase property value. Getting an appraisal after home upgrades can help solidify the increased worth, thus increasing your equity.
  3. Wait for it to appreciate. Property values are known to rise and fall with the economy. Though inflation may increase the overall equity of a home, its worth is more closely tied to the supply and demand of the real estate market. For instance, during times of high demand but a low supply of homes, home values are known to increase.

Second Mortgage vs. Refinance: What’s the Difference?

Refinancing your home loan also involves taking out a loan, but in this case, the new loan replaces your existing mortgage. People choose a traditional refinance to gain a lower interest rate, a lower monthly payment, a different loan term, or a fixed rate instead of an adjustable one.

 

Equity-rich homeowners may choose a cash-out refinance, taking out a mortgage for a larger amount than the existing mortgage and receiving the difference in cash.

 

Lenders look at your loan-to-value ratio, in part, to determine your eligibility for refinancing. (To find your LTV ratio, divide how much you owe on your current mortgage by the current value of the property and multiply by 100.) Once you know your LTV ratio, you can think about the loan amount you want to apply for. Just realize that most lenders favor an LTV of 80% or less.

Two cons of refinancing:

  1. Since refinancing means you’re taking out a new loan, you face closing costs.
  2. Just like a second mortgage, a refinanced mortgage uses your home as collateral, so the lender can seize your property if you fail to pay.

The main pros of refinancing:

  1.  Record-low rates could mean monthly savings.
  2. A lower rate or shorter term could translate to significantly less interest paid over the life of the loan.
  3. The rate for a cash-out refinance is typically lower than that of a home equity loan or HELOC.

There’s a lot to think about for homeowners pondering a second mortgage or a refi. You may want to ask yourself:

  • How much equity do I have in my home?
  • How much do I want to borrow?
  • When do I hope to repay the loan?
  • What’s my current mortgage rate?
  • Do I really want a fixed rate or is a variable rate OK?
  • Is adding debt with a second mortgage fine, or is refinancing my original mortgage the way to go?

The Takeaway

A second mortgage — a HELOC or home equity loan — can be advantageous for homeowners. So can a refinance or cash-out refi. It’s all about weighing your individual goals and needs.

 

Learn more:

This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.

 

SoFi Loan Products
SoFi loans are originated by SoFi Lending Corp. or an affiliate (dba SoFi), a lender licensed by the Department of Financial Protection and Innovation under the California Financing Law, license # 6054612; NMLS # 1121636. For additional product-specific legal and licensing information, see SoFi.com/legal.
SoFi Home Loans
Terms, conditions, and state restrictions apply. SoFi Home Loans are not available in all states. See SoFi.com/eligibility for more information.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

 

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What is mortgage amortization?

 

If you’re looking into getting a mortgage for the first time, congratulations! You’re about to embark on a brave new adventure in adulthood. Like most adventures, it comes with some highs and some lows.

 

One of the highs might be when you finally find the perfect home in your price range. As for the lows, one of them could well be trying to understand all the jargon that’s involved in buying a house.

 

Home-buying terminology can be somewhat intimidating. What’s the difference between prequalification and preapproval? Why are there so many different types of mortgage loans? What in the world is escrow? And what does amortized mean?

 

Related: Tips when shopping for a mortgage

 

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We’re going to answer that last question, quickly and painlessly. Basically, mortgage amortization just means that your mortgage loan payments will be spaced out over a set period of time (often 30 years) and will be calculated so that you always pay the same amount per month (if you have a fixed rate mortgage, not a variable rate mortgage).

 

That means that if you get a fixed rate mortgage and your first payment in your first month is $1,500, you know that you’ll pay $1,500 in the last month of your mortgage, years later. If you take out a variable rate mortgage, the amount you pay each month will change periodically as the market rate fluctuates.

 

Just because you’re paying the same amount for your fixed rate mortgage each month doesn’t mean that your payment is going toward the same things each month. In fact, your first mortgage payment will go primarily toward interest, and your last mortgage payment will go primarily toward the principal.

 

Throughout the life of your loan, this balance paying off interest to paying off principal will gradually shift as more of your principal is paid off (and therefore generates less interest).

 

Chainarong Prasertthai // istockphoto

 

Mortgage amortization helps ensure that your obligations are predictable, which can make it easier for you to plan. If you take out a 30-year mortgage, then the amortization helps guarantee that in 30 years, you will have finished paying it off.

 

For a fixed rate mortgage, amortization also keeps all your payments consistently the same amount, rather than different amounts that depend on how much your principal is.

 

 

SARINYAPINNGAM / istockphoto

 

In real life, even if you choose an amortized mortgage, you may never need to figure out your 30 years or so of payments yourself. But it’s useful to see what goes into the table or payments (they’re not arbitrary!) and understand how it’s populated. Calculating your amortized mortgage really puts you on the front lines of homebuying.

 

Let’s say you take out a $100,000 mortgage over 10 years at a 5% fixed interest rate. That means your monthly payment will be $1,061. You can then divide your interest rate by 12 equal monthly payments. That works out to 0.4166% of interest per month. And that, in turn, means that in the first month of your loan, you’ll pay around $417 toward interest and the remaining $644 toward your principal.

 

Next, to calculate the second month, you’ll need to deduct your monthly payment from the starting balance to get the ‘balance after payment’ for the chart. You’ll also need to put the $417 you paid in interest and $644 you paid toward the principal in the chart. Then you can repeat the calculation of your monthly interest and principal breakdown, and continue inputting until you finish completing the chart.

 

Gerasimov174 / istockphoto

 

So you can see that it’s not so much difficult to calculate your amortized payments as it is time-consuming. Fortunately, you can save yourself the trouble by using an online amortization calculator.

 

All you have to do is input info about your mortgage, including the amount you’re borrowing, your term length, and the interest you’re paying, and the calculator will do the math for you.

 

 

Mykola Komarovskyy/shutterstock

 

1. You’ll slowly but surely pay off the principal of your home loan

With every month, you’ll get closer to owning your home outright!

2. It ensures that you pay a set amount for each payment over the life of your loan

With some loans you may end up paying more at the beginning or the end. A balloon mortgage, for example, requires you to pay interest charges monthly during the regular term. You then pay off large parts of the principal at the end of the loan period. (Thus, your payment literally balloons.)

3. You can often get better terms with an amortized loan

And you’ll save money in the long run by paying less interest over the life of your mortgage.

 

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1. Larger down payments

Amortized mortgages favor borrowers who are putting down a larger down payment. To qualify for a competitive interest rate, you’ll probably need to put down 10% (if not 20%).

2. It’s harder to qualify

You might not be able to qualify to borrow as much money via an amortized mortgage as you would through an alternative mortgage, such as an interest-only mortgage or a balloon mortgage.

 

Learn More:

 

This article originally appeared on SoFi.comand was syndicated by MediaFeed.org.

 

SoFi Loan Products

SoFi loans are originated by SoFi Lending Corp (dba SoFi), a lender licensed by the Department of Financial Protection and Innovation under the California Financing Law, license # 6054612; NMLS # 1121636  . For additional product-specific legal and licensing information, see SoFi.com/legal.

SoFi Home Loans

Terms, conditions, and state restrictions apply. SoFi Home Loans are not available in all states. See SoFi.com/eligibility for more information.

External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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