Home equity continues to rise steadily, according to the Federal Reserve Board, and it is still rising faster than borrowers are withdrawing it. The attention that isn’t being focused on the low inventory of houses for sale has been focused on refinancing existing loans to lower interest rates. However, some homeowners that have gotten over the huge bust of the last of the last cycle when so many home values went underwater are again considering second mortgages.
If current homeowners aren’t selling so that they can move up to a bigger better house, should they being using existing equity to finance home improvements, additions, and other financial reasons? There are options as well as pro and cons to that question.
There are two basic types of second mortgages. One is a straight up loan secured by the equity you already own in your home. Typically, instead of 80 percent of the value of the home, a second mortgage can go as high as 80 percent of the equity you own. The second type of loan is a home equity line of credit (HELOC). Just as the title describes, you can access credit as needed by writing a check or using a credit card.
Generally, home mortgage interest is any interest you pay on a loan secured by your home (main home or a second home). The loan may be a mortgage to buy your home, a second mortgage (up to $100,000), or a line of credit. This makes a second mortgage enticing to use instead of other types of credit. A second mortgage or line of credit will probably be at a lower interest rate than a credit card and the interest is tax deductible.
On the other hand, you’re pledging your home as security. Failing to make payments on other sources of credit will ding your credit score but it’s extremely rare for others to foreclose on your home. If you miss payments on a second mortgage, the lender can place a lien on your home and eventually force it into foreclosure.
Another important consideration between credit cards and second mortgages is that some home equity loans come with additional fees, such as an early closure fee, as well as minimum draw amounts that may exceed your personal needs. Be sure you read all the fine print to avoid any surprises.
It can be a good thing if you’re taking out a second for home improvements, as a down payment on an investment property, or another worthwhile one-time purchase. It’s quite another thing to be taking out a second to finance a vacation you otherwise couldn’t afford or to consolidate other debt that you’re having trouble paying off. If you’re considering taking out a second mortgage to pay off debt, you need to be careful. Too many people consolidate their debt and then find themselves with a large amount of new credit card debt in a short amount of time. The reason is they didn’t address the problems that caused them to go into debt in the first place. Keep in mind this puts your home at risk because you are moving unsecured debt to your home. If you cannot make your payments, you can lose your home.
Home equity loan payments are generally easier to manage because you can set up your budget knowing that you’ll pay a set amount of money every month for that second home loan. The amount you owe on a HELOC (and maybe the interest rate) will vary and so will your monthly payments. If you diligently pay off your HELOC, your monthly payment will remain constant or decrease. When you continue accessing your line of credit the monthly bill goes up.
Prudent people ‘save’ their equity for when they retire or to sell the home and move up to a new one. Moving the saved equity into the more valuable home. Before taking a second mortgage, be sure you have a plan for your financial future.
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