Second mortgages are a popular way for homeowners to get approved for a loan. If you are sure you will be able to pay back the loan, it can be a fairly secure financial decision. However, you should do some homework and serious number crunching before signing on the dotted line. Knowing your equity and credit history will help you find the lowest interest rates and fees. You can also calculate how much money you can expect to borrow based on your equity and the appraised value of your house
1. Understand the risk of a second mortgage. A second mortgage adds to your monthly bills. It comes at a high interest rate because it is a risky investment for lenders, since they would be paid off after the primary mortgage company in the event of foreclosure. Seriously consider if you want your house to serve as collateral for this kind of loan.
- Using a second mortgage to pay off a high-interest loan may help you lower the interest you're paying in the short term. However, it is very risky to put your house on the line to reduce your debt.
2. Do a realistic budget.You want to make sure payment on a home equity line of credit is affordable. In general, you only want a third of your combined household income to go to housing costs. This includes any rent, mortgage payments, utilities, property taxes, homeowner's insurance, and any additional community fees.
3. Determine what kind of second mortgage you would like. There are two main kinds. Home equity lines of credit (HELOCs) are open-end, meaning that you can continue borrow money up to the limit even as you pay back the loan. A basic home equity loan is closed-end, meaning that you get one sum and may not borrow more money later.
- HELOCs are similar to a credit card – you only have to pay back the amount you borrow. This may be more useful if you need a small, but yet to be determined, amount of money.
- One drawback of a HELOC is that some lenders will not let you take out additional credit if the value of your property drastically decreases.
- Home equity loans are good for a lump sum. If you have, for example, an estimate for building an addition to your house, you know exactly how much money you will need. This situation would call for a home equity loan.
4. Find out your credit score. In the world of money lending, your credit score is used to approve or deny your application. It also determines what interest rates, or APR, you qualify for. You can get a free credit report from a federally approved agency such as Experian or Equifax once a year. This should give you an idea of how good your credit score might be. However, remember that the free credit report does NOT include your score. You have to pay to see that.
- If you have never seen your score before, it is best to pay for your actual credit score. However, you can get a free FICO score estimate on the internet. This scale is used as the basis of many credit scoring agencies.
- For more on checking your credit score.
5. Determine how much equity you have in your home. Equity is the difference between the value of the house minus the amount you owe. That means if you still owe $60,000 on a $100,000 house, your equity is $40,000. This number will be used by lenders to calculate how much money they can loan you with a second mortgage.
6. Have your house appraised. The other number you need to know up front is the value of your home. Some factors to consider when estimating this are the price you paid, any changes in neighborhood, and any additions you have made. You can also look at similar houses in the neighborhood that have gone on the market recently. Consider having your house appraised by a professional before you apply for a second mortgage