You may never be as popular as today's second mortgage, but it could be your best friend. In today's finance-friendly world, it seems like everyone is getting a second mortgage or home equity line of credit – and as interest rates climb, their popularity grows. Even so, you still need to ask yourself: what are the advantages and disadvantages? Time to do some homework – the kind of homework that could save you thousands of dollars.
"It's not about loans; it's about changing people's lives for the better," says Rory Cambra, president of the North San Diego County Chapter of the California Association of Mortgage Bankers and a mortgage banker with Pacific Capital Mortgage.
What is a second mortgage? Quite simply, it's another mortgage on your home, and like the first, it's secured against your property or the equity you've built up over the years. They can be fixed-rate or adjustable-rate.
So, what's the difference between a second mortgage and a home equity line of credit?
"A second mortgage is a lump sum. A home equity line of credit is basically an open checkbook," Cambra says. Lump sum loans are best when you need all the money at once .. A line of credit is best when your cash needs are stretched out over time, like a series of home improvements or college tuition payments.
Equity is the difference between your home's value and the balance on your mortgage loan. If your home is worth $ 500,000 and you owe $ 400,000 on the mortgage, then you have $ 100,000 of equity.
"Americans have hundreds of billions of dollars in equity, but most don't understand that the equity in their home is not safe, liquid or growing," Cambra says. "Everything from market conditions to disasters can significantly affect your home equity. It could literally just go away." Before you decide to jump in to the second mortgage waters, assess your family's financial needs and goals; explore the variety of second mortgage products, and understand how each type best serves your financial picture. Then consider the following:
Second Mortgage Advantages (They increase the more homework you do)
Make your equity work for you. It's a good thing to separate your equity from your mortgage and put it in a safe, liquid and growing environment. "You're not doing it to conserve your equity; you're doing it to create wealth. It can even be used to create your retirement nest egg," Cambra says.
A cash cushion. Cambra tells his customers that the best first use for your second mortgage is creating a cash cushion, suggesting a minimum of $ 5,000 be put away for emergencies. Why? So you won't turn to credit cards the next time an unforeseen financial need pops up.
Pay off debt.
A non-brainer: pay off all your high-interest debts, including credit cards.
Serious liquidity. You can create serious liquidity, like socking away one year salary in the bank. (We can dream, can't we?) Pay for your child's education. That sigh of relief you just uttered is reason enough.
Consider this: If you use the proceeds from your second mortgage properly, you can – on paper – pay off your house in full. The key words being, "on paper." Obviously, you don't want to miss all the financial and tax benefits that go with your mortgage, but according to Cambra, creating wealth on a balance sheet that is equal to the amount you owe is an accountant's dream.
2nd Mortgage Disadvantages (They decrease as you do more homework)
Dealing with fear and stress. Everyone has trepidations when it comes to property finances. Fear causes some homeowners back away from a second mortgage. But if you educate yourself, and are prudent with the proceeds, you really haven't increased your risk.
Not protecting your home.
Be realistic about estimating your future income. If for some reason you cannot pay back the second loan, it could be disastrous. Consuming the proceeds of a second mortgage unwisely. Some homeowners use a second mortgage to take a lavish trip, buy that fantastic new car they've always wanted or spend it on frivolities. Then they end up going right back to their credit cards. "It's a fact: we are human, and we are driven by the pleasures of the world – and those are usually depreciating assets," Cambra says.
Second Mortgage Costs, Fees & Charges.
2nd mortgages have more defaults, so it's common for lenders to charge more fees up front. Prepare for and budget the costs. You might also have appraisal fees, points, applications costs and other closing costs. Ask your lender – beforehand – for a printed list of fees.