Second Mortgages for Home Improvement and Major Purchases
A second mortgage is a type of secured financing, which is considered subordinate. This means that there is another loan against the same real estate property. Payments are made only after the first mortgage has been paid off. Because financial institutions take more risk, they offer a higher interest rate than on other types of debt.
Uses and Benefits
Many people opt for a second mortgage to finance large purchases and products, including home improvements, car purchases, tuition, and others. Some people also use the money to pay off high interest debts and credit cards. The main advantage is that interest is tax deductible. Borrowers who seek to buy a home and cannot make a large down payment also opt for a second mortgage. This is one way to avoid buying an insurance policy. They can use the money to make a down payment of 20 percent. Some borrowers also apply for a loan to buy a second home, cottage, or investment property. Other people apply for a loan to consolidate their debts, including consumer loans and credit card debts. The funds can be used to finance the purchase of machinery and equipment and in times of cash flow shortages.
In addition to interest charges, borrowers pay processing and application fees, for title research, appraisal, and other fees and expenses. The main disadvantage, however, is that the borrower’s home serves as collateral. Foreclosure is not an issue with unsecured loans. However, these loans are more difficult to obtain, and financial institutions require a very good or excellent credit score to meet the lending criteria.
Types Offered to Borrowers
There are two types of loans to choose from, home equity lines of credit and home equity loans. A HELOC is a type of loan offered to homebuyers who can offer a real estate property as collateral. People often opt for a home equity line to consolidate high interest debt such as auto loans and credit cards. Others use the money for refurbishment and home improvement.
HELOCs are considered a flexible borrowing tool and an affordable way to finance different projects. They are offered with a low interest rate, and borrowers can choose from a fixed or variable-rate HELOC. The problem with variable rates is that the cost of borrowing may increase with interest rate fluctuations. It may affect the monthly payments and the long-term costs. At the same time, the monthly payments decrease when the interest rate drops. Having a home equity line of credit is similar to paying an adjustable-rate mortgage. This makes it more difficult to predict the cost of borrowing and the monthly payments and to make future plans. Thus, a HELOC is not a good option for borrowers with a low risk profile.
Note that banks offer HELOCs to borrowers who pledge their primary home as collateral. This product is not available on rental homes, investment properties, and cottages. They are a good option for borrowers who want to draw on the line at any time. Moreover, customers can choose from different payment options. They can convert the line of credit to a fixed rate loan, which makes budgeting and planning easier. Another option is to make interest-only payments. Some financial institutions offer HELOCs with no closing costs, application fees, and fees for online transfers. The draw period normally lasts between 5 and 25 years.
A home equity loan is another option for a second mortgage. Borrowers who opt for a loan benefit from fixed interest and principal payments. They can apply for a loan with no closing costs or application fees and affordable payments. The term and schedule of repayment vary from bank to bank. Some financial institutions offer loans with terms of up to 25 years. Borrowers who want to repay their loan sooner can opt for a term of 3 or 5 years. The funds are paid in different ways – through bank transfer or check. One of the main advantages of home equity lines and loans is that interest charges are tax deductible. There are similarities and differences between the two products. Like HELOCs, home equity loans are not available on cottages and rental and investment properties. The interest rate on home equity loans is often higher than on HELOCs. The reason is that the loan comes with a fixed rate. As a rule, home equity loans are a good option for borrowers who want to receive the funds as a lump sum and pay in monthly installments.
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