Norma admits to going a little crazy on her credit cards lately after her husband of 20 years divorced her. She hired a personal trainer, bought all new clothes, traveled and felt like she hadn't had so much fun in years, dating many men whom previously she felt were out of her reach. She realized she was in trouble when a third of her take home pay started going towards paying off her credit cards, and she was no longer able to make more than the minimum payments. She confided her troubles to the new man in her life who suggested that she take out a second mortgage on her nearly paid-off home to pay off her debts, and confessed to her that he had recently done the same thing.
What is a second mortgage?
A second mortgage is a loan secured by real estate that already has a primary or first mortgage on it. The maximum amount of the second mortgage is determined by the equity in the home. The equity is the difference between what is owed on the home and value of the home:
Value of home - Total amount of loans = equity
Why would I want a second mortgage?
Many people use a second mortgage to pay off credit card debts or other kinds of debts, seeking to lower their total monthly payments. Some people say this is a way to save money, as the interest from a second mortgage is deductible, where credit card interest is not. If you are making the minimum monthly payments on your credit cards, you'll be paying on them for about 30 years anyways, so the low interest on second mortgages may be a good deal for you. (Don't think you'll be paying on your credit cards for 30 years if you only pay the minimums? See Chapter X, All about credit cards.)
Other reasons people take out second mortgages include home improvements, business loans, etc. In most cases, people are trying to tap into the cash equity in their homes.
Are second mortgages a good idea?
Second mortgages can be dangerous, actually hurting you in the long run. Do you really want to pay for that romantic dinner you had last month for 15 years with interest? That's essentially what happens when you use the proceeds from a second mortgage to pay off your credit card bills. If you have had a tough time controlling your credit card spending in the past, what is going to happen when you suddenly find yourself with zero balances on your credit cards? Sadly, many people find themselves in the position of first paying off their credit cards with a second mortgage, only to find the cards maxed out again in a year's time or less.
What kind of credit do I need?
As in first mortgages, there are a wide variety of programs to fit most every credit need. If you have perfect credit, there are many programs out there that will loan you upto 125% of your equity. Yes, this means that even if you have no equity, you can get a second mortgage.
However, also as in first mortgages, the worse your credit is, the higher the interest rates are and also the less you can borrow against your equity. For instance, if you have less than perfect credit, a lender may only be willing to loan you up to 80% Loan-to-Value (LTV). For instance, let's say you have a $200,000 house and the lender is only willing to loan up to 80% LTV due to your credit. You owe $125,000 on the house:
$200,000 x 80%/100 = $160,000
Therefore since you owe $125,000 on the home, you will be able to get a second mortgage for $35,000. (Of course, your interest rate may be 11%, but hey, that's beside the point.)
For more information on what kinds of credit and income you need to qualify for a "A" credit type second mortgage, refer to our "A" credit criteria.
Types of Second Mortgages
Home equity line of credit - This type of mortgage is typically an Adjustable Rate Mortgage (ARM). The interest rate on this loan will be fixed for a stated period of time and will then become adjustable for the remainder of the loan. This adjustment is based on changes in a pre-selected index, and will take place according to a pre-defined schedule (generally once a year). Your interest rate and monthly payment will fluctuate based on changes in your index. The most common indices are the Treasury Bill, Certificate of Deposit (CD), London Inter-Bank Offered Rate (LIBOR) and Cost of Funds Index (COFI).
A line of credit is much like a credit card: you have a maximum limit, and you are able to take out any of amount of money up to the amount of the maximum over the life of the loan. You may also pay off the entire amount ahead of schedule, but keep the line open for future withdrawals. Unlike a credit card, though, the line of credit has a fixed life, or length of time to withdraw from and pay off the debt. When the life of the loan is over, you must pay off the entire balance or refinance it.
Fixed Rate Mortgages - These are second mortgages which have a fixed interest rate and a fixed term of a loan. Typical lengths of second mortgages are 15 and 30 years.
GLOSSARY TERMS
COFI (cost of funds index) - The cost of funds is indexed to the average interest rate that banks in particular states pay their customers. One of the most common indexes is the 11th district cost of funds index, which covers banks in California, Nevada and Arizona.
Equity The equity is the difference between what is owed on a home and value of the home:
LIBOR London Inter-Bank Offered Rate. This is the interest rate at which highly rated American and International banks lend to one another. LIBOR is an international index that follows the world economic condition.
Do you have a question you feel we haven't answered?
For a small fee, you can talk to a counselor on the phone or Buy the Book!
|
