The term second mortgage is rarely used these days in favor of words that describe specific products that are offered using real estate as collateral. Second mortgages historically accompanied the initial loan and were termed creative financing as they were often used to provide or to supplement the down payment amount. This use for a second mortgage has changed over the years. One thing remain the same. It is a good idea to save money for the indulgences of life and borrow money from your home only for serious necessities.
Becoming A Qualified Borrower
Second mortgages came to life in the commercial real estate market. They are based on a loan-to-value (LTV) ratio, taking into consideration the appraised value of the property minus the first mortgage. Lenders use this amount compared to the appraised value as a guide to determine the amount of equity available for a second mortgage. The LTV ratio is set at
70% - 80%, but has a tendency to vary among lenders. Another criteria for consideration is your income-to-debt ratio. There is little chance of obtaining a second mortgage if your debt overrides your income.
Lenders Point Of View
Today, these second mortgages have source-defining names: home equity loan, home equity line of credit and debt consolidation loans. Each product has its pros and cons, but they have one thing in common: they all use the borrower’s home as loan collateral. Lenders consider these loans to be a bit riskier than a first mortgage because they have no priority for payment in cases of foreclosure, default or bankruptcy. This is the reason for the
shorter terms and higher interest rates.
Borrowers Point of View
Second mortgage home loans are perfect for the time when you need a lot of cash fast: home improvements, college tuition or debt consolidation are some examples. A lender would consider these as valid reasons for a second mortgage using the equity of your property. This second mortgage may be the only way to pay for “big ticket” needs, both anticipated (college tuition) or unanticipated (short term nursing care).
Second Mortgage Benefits
Here are some BIG benefits allowed to a borrower who uses the home as collateral for a loan. The first benefit is that you could qualify for a larger loan. Most lenders hesitate to fund home loans below $30,000, calling them unprofitable. They find also that borrowers are most diligent about paying off a larger loan because they want to regain the equity that they used to make the loan.
The second benefit is that interest paid on home loans is tax deductible and this applies to both your first mortgage and your second mortgage.
The third benefit is that you can also deduct from your earned income any amount of your second mortgage that you contribute to an IRA or S401(k). Any amount over 7.5% of your adjusted gross income, which was paid out for medical needs is also deductible.
Second Mortgage Drawbacks
The biggest drawback is that you need a second mortgage on your home. It is a debt with a large principal balance that will influence your credit for years to come. There are two considerations to be made and you really need to look at both sides of this coin: getting a second mortgage or refinancing the first mortgage up to the larger amount.
The second drawback is the difference between a “teaser” offer and the actual product available to a person of your circumstance. Make sure you know your lender’s reputation for ethical lending and integrity. The best lender to approach is the one holding your first mortgage because they already have a relationship with you.
Finally, read and understand the terms and fees associated with your loan. Those fees could be a deal-breaker. Sometimes they are “hidden” fees rolled into the principal of a second mortgage. If you thought you were applying for $50,000 and the principal actually is stated as $52,660, you will be paying an additional $2,660 in fees over the life of the loan. You can lower the amount you want, go elsewhere or live with the situation.
Summary Thoughts
1) You get what you pay for. Buyer beware.
2) Get everything in writing.
3) Any arrangement that appears too good to be true, probably is.
4) Read the fine print. If you don’t like it, you have 72-hours to back out of
this commitment.