HELOCS & SECOND MORTGAGE
HELOCS/Home Equity Lines of Credit function similarly to a revolving loan. Stand Alone Second Mortgages are fully amortized loans that follow a set schedule for repayment with no additional advances allowed.
What is a HELOC?
A home equity line of credit or HELOC is a loan in which a private lender, like HomeXpress Mortgage, agrees to lend a maximum amount within an agreed upon period. This amount can be drawn on as needed. Basically, it is a revolving credit line that you can use for anything. You have access to the entire credit line and can spend as much or as little as you want. You only pay interest on the amount you spend. A HELOC is different from an installment loan — such as a home equity loan or personal loan — where you receive the full loan amount in a lump sum upfront.
HELOCs traditionally work on a 30-year model. You will have a 10-year draw period where you can draw money from your HELOC. Then you will have 20 years to pay off whatever you spent. However, other lengths of draw periods and repayment periods also exist.
If you have an interest-only HELOC, you’ll only be required to make payments that cover the interest, not the principal, during the draw period. You will begin full principal and interest payments during the repayment period. However, experts recommend making payments toward your principal during the draw period if you can, to avoid larger monthly payments during the repayment period.
Criteria for a Home Equity Line of Credit
Is a HELOC Loan the right type of loan for you?
If you have home equity to tap into, a HELOC can be a good option to fund larger projects like home renovations or consolidating debt. But it is important to remember that HELOCs are not without risk.
Home Equity Loan
A home equity loan is an installment loan that is secured by your home. You will receive a lump sum payment that you can use for any purpose. You will then have set monthly payments until you pay back what you owe. Unlike a HELOC, a home equity loan has a fixed interest rate. This means that your interest rate and monthly payment will not change, even if market interest rates increase.
A personal loan is an installment loan that lets you borrow a lump sum of money upfront, at a fixed interest rate, and pay it back in monthly installments. Unlike a HELOC, home equity loan, or cash-out refinance, a personal loan is typically unsecured and requires no collateral. This makes them riskier for the lender, which is why personal loans tend to have higher interest rates and require a good credit score for approval.
WHAT IS A SECOND MORTAGE?
A second mortgage is a type of loan that lets you borrow against the value of your home. A second mortgage uses your home as collateral, similar to the loan you used to purchase your home.
Second mortgages are often used in situations such as home improvement or debt consolidation. Advantages of second mortgages include higher loan amounts and potential tax benefits. Disadvantages of second mortgages include the risk of foreclosure, loan costs, and interest costs.
Second mortgages tap into your home equity, which is the market value of your home less any loan balances. Equity can increase or decrease, but ideally, it grows over time as you pay down the balances of your mortgage(s).
Equity can change in a variety of ways:
- When you make monthly payments on your loan, you reduce your loan balance, increasing your equity.
- If your home gains value because of a strong real estate market or the improvements you make to your home, your equity increase.
- You lose equity when your home loses value or when you borrow against your home.
What Can a Second Mortgage Be Used For?
Some people use a second mortgage to cover a down payment or even closing costs. Others take out what is known as a “piggyback” second mortgage to qualify for their main mortgage and avoid paying private mortgage insurance (PMI), even if they don’t have enough cash on hand to make a down payment of 20% on their home.
You might qualify for a 10% down payment, 80% of the mortgage, and 10% with a piggyback second mortgage instead of paying 10% of the home value with a down payment and 90% of the remaining value with a mortgage that requires PMI.
Pay Off Debt
Debt consolidation is a common strategy that involves combining multiple debts into one, often a lower-interest loan. People who have built up enough equity in their homes sometimes take out a second mortgage, so they use their home equity to pay off high-interest debt, but that doesn’t pay off the first debt. Some people consolidate their debts, only to find themselves in debt again within a short amount of time.
Taking out a second mortgage to pay off debts puts your home at risk because you’re moving unsecured debt to your home.
Home Improvements and Education
Home improvements and renovations are a common use for second mortgage funds because the assumption is that you’ll repay the loan when you sell your home with a higher sales price. You can also get a tax break for home improvements if you make capital improvements like switching to central air or adding an addition to the house, or if you make energy-efficient improvements. Second mortgages can also be taken out to pay for education expenses.
Should You Get a Second Mortgage?
If you believe you can repay the money you borrow through a second mortgage, then it might be right for you. Second mortgages can help you with down payments and debt but can also be used for home renovations and education.
Consider how you plan to use the funds from your loan. It’s best to put that money toward something that will improve your net worth (or your home’s value) in the future.
Once you decide whether you can afford a second mortgage, take the time to plan out how you’ll use the money. Reach out to one of our experienced professionals today to go over your specific lending needs.