2nd Mortgage Loans: 5 Things To Know

When homeowners need a large amount of cash, 2nd mortgage loans are one source to potentially tap. This isn't the perfect solution for everyone, however. Before you make such a commitment, here are 5 things to consider.

Home Equity or HELOC Loans

When you apply for a 2nd mortgage, this is a loan that is secured by your property. Unless your home is paid off, you are carrying a primary mortgage. You may be able to qualify for a 2nd mortgage, also called a home equity loan or HELOC (home equity line of credit) if certain conditions are met. In the event you become unable to pay your mortgage(s), the primary mortgage always takes precedence over the 2nd mortgage loan.

Requirements are Tougher

With a 2nd mortgage loan, you are borrowing on your home's value less what you owe on your first or primary mortgage. Loan rates for 2nd mortgage loans may be heading down in the current market, but the qualification requirements are becoming more and more stringent. Some of this is due to the number of banks that have failed and some is due to the high rates of foreclosure among borrowers. The net result is that conservative banks are tightening requirements to get a 2nd mortgage.

  • More lenders are demanding impeccable credit (no late payments, no defaults) and higher FICO scores. Homeowners with FICO scores of 630 used to be able to obtain a 2nd mortgage loan without trouble, whereas today, lenders are requiring scores of 700 and higher. One statistic points out this difficulty: 27 percent of the population of the U.S. has FICO scores ranging between 600 and 699.
  • High loan-to-value 2nd mortgage loans are gone. This is the amount of mortgage debt outstanding relative to the market value of your home. Not long ago, homeowners used to be able to borrow up to 125 percent of the home's value. Now, that percent is more in the area of 70 to 75 percent.
  • Stated income loans are also nearly impossible to obtain. Without complete income documentation, you may not qualify for that 2nd mortgage loan. This makes obtaining a 2nd mortgage loan more difficult, if not impossible, for self-employed homeowners, or anyone else unable to provide full income verification and documentation.

Advantages

There are several advantages to having a 2nd mortgage loan to consider. First of all, if you need a large amount of cash, you may not be able to get that much from your credit cards, and you may not have enough in your savings or want to deplete what you do have. Some of the reasons people go for a 2nd mortgage loan include home remodeling and improvements, debt consolidation, buying another home, avoiding private mortgage insurance (PMI), and creating a HELOC (a line of credit you can use when you need it).

Just like a primary mortgage, the interest on a 2nd mortgage offers the benefit of a tax deduction for income tax when you itemize deductions. Since the amounts of primary and 2nd mortgages can be significant, minimizing income tax with home mortgage interest deductions makes fiscal sense.

Disadvantages

When you take out a 2nd mortgage loan, you are taking an additional risk. Since your 2nd is secured by your property (your home), if you default on your loan, the lender can take your home.

In addition, loan interest rates for 2nd mortgage loans may be higher than those of the primary mortgage. These loans can be structured as fixed-rate or adjustable-rate home equity loans.

You may also have to pay higher fees for the 2nd mortgage loan.

Where to Get One

Large banks and mortgage companies are sources of 2nd mortgage loans. You should contact your existing mortgage lender to see if their rates and fees are better than what else is out there. At least, you have a relationship with the lender and may be able to cut down a bit on fees. You may also want to check out banks or credit unions where you have accounts, or enlist the help of a mortgage broker.