A second mortgage is a secured loan in which the borrower uses his home as collateral. Generally, borrowers opt for this type of mortgage to improve their homes, finance large purchases, including properties, consolidate or pay off debt.
Before diving into the advantages of taking out a second mortgage, it’s essential to know that this mortgage comes in two basic types: 1) home equity loans, provided as lump sums of money the borrowers need to repay at regular intervals over a fixed period of time; 2) home equity lines of credit, which allow homeowners to spend the money as needed.
Just like any other loan, second mortgages carry a few risks; but they bring along some great advantages as well. In the next paragraphs, we’ll go over the top three benefits.
1. Refinancing Avoidance
Most borrowers who need a large amount of money are tempted to do a cash-out refinance. Unlike second mortgages, a cash-out refinance will wipe all the equity built up in the home and restarts the amortization process. In the first few years, the payments will go mostly towards the interest again, which basically means that the borrower won’t be able to build equity too soon. With a second mortgage, on the other hand, the borrower will make a separate, shorter-term home loan that he can pay off more quickly compared to a cash-out refinance.
Whether a homeowner should apply for a second mortgage or a cash-out refinance depends on his specific situation. When interest rates go down, refinancing may be the best choice because the borrower can get a lower rate than the one he’s currently paying. In case of a rate increase, getting a smaller second mortgage makes more sense than refinancing a higher amount at a higher rate. What’s more, since second mortgages are based on the amount of equity, borrowers are likely to have access to more money than they might get with credit cards or personal loans.
A Valid Alternative to PMI
The home buyers who cannot afford to put down 20 percent of the home’s value are usually required to buy private mortgage insurance, or PMI, which is meant to protect lenders’ interest if the borrowers default on their loans. What many home buyers don’t know is that they can use second mortgages as alternatives to paying PMI. For instance, a borrower can make a 10-percent down payment, get a second mortgage to cover the other 10 percent and finance the rest of the 80 percent of the purchase price on a first mortgage.
When deciding between paying PMI and taking out a second mortgage, a borrower should consider the tax savings associated with both the PMI and the mortgage, and the total cost of PMI versus the cost of the mortgage.
According to the IRS Publication 936, the borrowers can deduct interest as long as they use second mortgages to buy, build or improve their homes (up to $500,000 for singles/married people filing separately; up to $1,000,000 for couples filing jointly), to make purchases or pay off debt (up to $50,000 for singles/married people filing separately; up to $100,000 for couples filling jointly).
Second mortgages with low interest rates and advantageous terms and conditions aren’t that hard to find.
Whatever it might be – a second mortgage to fund a renovation, a refinance of your current home loan or a mortgage for a brand new home – our experienced Florida mortgage professionals can help you obtain affordable financing, while preventing you from tackling a mortgage that you can’t repay comfortably.