Is It Worth Considering A Second Mortgage?

While you may be willing to opt for a second mortgage, how do you know it’s the right decision for you? There are many reasons why homeowners with a mortgage on their home may need another loan against the same house. In this article, we consider why you might opt for another mortgage and when it’s a better option than other funding types.

What is a Second Mortgage?

Not every homeowner knows what a second mortgage is and nor it works for the mortgagee (lender) and the mortgagor (borrower). The second mortgage denotes that there is already a mortgage using the home as security. The first mortgage will be larger, and it could be as much as 80 per cent or more of the sales price when the house was purchased.

Over time two things co-occur that provide homeowners with an option to borrow more using the same home as collateral.

The value of the property will typically go up, for example, let’s say the house was purchased for $300,000 two years ago, and the cost today is $330,000; the difference is $30,000, and that’s called equity.

The more years between when the house was purchased and when it’s valued, the higher the equity stake. It’s not just the rise in value that improves the equity in the property when the mortgagor makes principal and interest repayments, the value of the loan reduces, which increases the equity position in the home.

A second mortgage against the equity in the property is an attractive option.

Advantages of taking a Second Mortgage

An expert mortgage advisor at Get Me My Mortgage says the reasons for choosing a second mortgage include:

Debt Consolidation

A homeowner with equity in their property has the opportunity to consolidate several debts such as a high-interest credit card under the second mortgage. This action will allow the homeowner to repay the high-interest debt immediately and be relieved of any further liabilities regarding that loan and then pay the consolidated debt via the second mortgage which will be a much lower interest rate.

Tax Planning

Depending on the tax laws, in your region, the mortgagor may be able to deduct the interest on the second mortgage against the tax they’d pay on their income.

Property investors may be able to take out a second mortgage against a home in their property portfolio to get the tax benefits on future rental property income tax. When it comes to tax, accounting and legal requirements always get professional advice before signing contracts.

By taking out the home equity line of credit, there will be an opportunity to make improvements to the home as homeowners can cash out the equity of their home.
Finally, just compare the cost of taking out the second mortgage and long terms of saving potentials. If the long-term saving potential exceeds the cost, then the second mortgage is a worthwhile investment.

Buyer Beware There Are Risks

Remember a second mortgage is a loan and if you don’t meet the repayments, then you could face penalties or at worst foreclosure on your home. Also, the loan is not free; you do need to pay the interest and other loan costs, for example, there may be an initial admin fee for setting up the loan.

There is various type of loans, and they too can be second mortgages.

Types of Second Mortgages

Home Equity Line of Credit (LOC)

An equity LOC is a pool of money homeowners can draw down and also pay-back. For example, the homeowner may want to renovate the kitchen and will draw down $40,000 from the LOC. Interest is incurred as soon as money is drawn and it stops as soon as it is paid back.

The equity LOC is also used a lot by real estate investors who may use it to fund the deposit on a new rental property, and over time repay it so they can draw on it again.

Closed-End

This type of second-mortgage is a fixed loan amount that needs to be returned within a fixed timeframe. This is a good loan option for homeowners who have a one-time specific need for funds, and they do not want continuously access like a LOC.

Summary

All mortgages have a degree of risk, and this is why it’s essential to understand your obligations and liabilities as a borrower when taking out a loan.

Engage a mortgage broker or financial advisor to understand the loan types, features, and risks. Plus also speak to your accountant and or lawyer before signing a contract. See our ‘finance’ category for more articles on financing real estate.