Alright, you just bought a home and got your first mortgage. You've been paying it down for a while and everything is looking good. Suddenly, you get a letter in the mail telling you that you're eligible for a second mortgage. You think to yourself "What is a second mortgage and why would I need one if I have my first mortgage?" So let's look at what a second mortgage is, what it means, and why you would ever need one.
What is a second mortgage?
A second mortgage is exactly what it sounds like, a mortgage you take out after your first one on the same home. Just like any other mortgage, you would be using your house as a collateral in order to get the loan. So, just like any other mortgage, on the loan, you would risk losing your home to foreclosure.
There are two main types of mortgages you could take out, a home equity loan and a home equity line of credit. A home equity is like a traditional loan, where you will get the loan money up front to use and cannot access it over time. However, a home equity line of credit, similar to a credit card, allows you to draw credit as you want against the equity of your home. Just like a credit card, you have a limit and will pay back the amount you spend, except this time you borrow against your homes value.
When should you take out a second mortgage?
People take out second mortgages for various reasons, ranging from home improvement, to affording a down payment on a home. If you can't afford the closing costs on a home or want a larger down payment to avoid getting PMI insurance, a second mortgage can do the trick. Just know that this second mortgage could come with a higher insurance rate and you will have to pay it back over time.
Another popular reason to take out a second mortgage is to consolidate your debt. If you have a lot of loans, you can pile them into one loan that uses your house as collateral. This can help you lower your interest rate and payments, but remember that if you miss a payment, you could have your home foreclosed on. A second mortgage can be a great way to save money on expensive loans if you have the financial stability to afford it. This can also be risky if the value of your home were to fall and you were suddenly underwater on your mortgage.
Is it worth it?
Always be weary when you are debating if you should take out a second mortgage. If you're taking out the second mortgage to make a larger down payment, you should look into how much PMI insurance would be compared to the cost of interest on a second mortgage. This could help you determine which of the two options would be best for you. Of course, the way around having to do either of those is to put a down payment of 20% on the home from the beginning. This would give you a better start to homeownership.
If you want to consolidate debt, remember that you could go underwater quick if the value of your home falls. You could also have your home foreclosed on if you can't afford the payments. It's important to always make sure your finances are sufficient to take out a second mortgage.
