We love to dream big, but when our dreams don’t match our bank accounts, it is time to become financially creative and look for solutions. One way to get more money fast is to use your home as collateral and get a second mortgage, also known as a “Home Equity Loan”.
The name also gives a clue about how this arrangement works, namely by tapping into the percentage of your home you’ve already paid. You are actually getting credit for the part covered by the initial down payment, and the monthly installment paid so far.
Therefore, you can’t ask for this type of credit immediately after buying a house. You have to wait a bit so that your asset gains some value either by making payments or due to an upswing of the market.
Why would you need a second mortgage?
Getting a home equity loan is usually a way to access a considerable amount of money, typically necessary to fulfill a bigger goal. Think about investing more in real estate, getting an education or covering important medical bills. Some people get second mortgages to start their business, as a way to get capital at a lower rate than they would get otherwise.
No matter what are your motivations, keep in mind that you are putting your home on the line. Since this is a secured loan and you use your house as collateral, you could lose it if you are unable to make the payments on time.
Try to use this as a financing method if you plan to take the money and invest them in something with an excellent potential to generate even more money. For example, you could renovate an attic or the basement and rent it on Airbnb.
What are the pros of a home equity loan?
If you qualify for a second mortgage, there are plenty of reasons to choose this as a solution to grow your dreams. Here are the top three.
The first advantage of this type of loan is that you get a significant amount fast. Depending on your specific situation, you could get up to 80-85% combined debt ratio of your home’s value. Be careful that this is the total debt rate you can get, considering all your other loans, like your first mortgage, car loan, student loans, and any other credits.
Better interest rates
Since interest is directly related to risk, and this is a low-risk loan, you can get interest rates which are a few times lower than those of credit cards or personal loans. When you guarantee with your home which holds enough value and it is usually easy to sell the bank doesn’t think it over exposes itself.
In some situations, you would get a deduction for the interest paid on your second mortgage. There are numerous boxes to tick to get such a fiscal facility, so by no means, should this be a motivation to get a second mortgage. In the best case, this is a nice to have and good to know about. Right now, the fiscal regulation limits the application of this law to loans taken for substantial home improvements.
These types of loans always come with a fixed interest rate. There are no surprises related to how much you have to pay over the years. This is a comforting thought and helps you manage your budget better.
What should you be aware of when taking a second mortgage?
Of course, getting into more debt can’t be all good. You are exposing yourself and your family to high risks. The most important of these is the foreclosure possibility.
Even if the credit institution or bank allows you to accumulate up to 80% or a bit more debt, you have to take only as much as you need. Think about the financial pressure you are putting on your budget every month for the next decades. Also, keep in mind that unemployment, salary cuts or medical problems happen and could impact your ability to repay the loan.
Any loan means that for the money you get upfront you pay the price in time. The most prominent cost is that of the interest. Although these rates are lower than those of credit cards, the interest rate will still be usually higher or equal to that of your first loan, because a higher debt ratio means more risk.
Although this should not be the first choice, a home equity loan is a solution if you need a lump sum to grow. Before signing the papers, make sure you educate yourself about all the matters by reading How a Home Equity Loan Works: The Pros and Cons from a financial advisor.