Although there is technically no limit to the number of mortgages that you can have at once, it is incredibly rare, especially after the housing market crash, to have more than two mortgages at once. With the additional risk taken on by lenders, and the additional headaches and fees for the homebuyer, a second mortgage may not be ideal on paper. However, if it is executed for the right reasons and with a buyer that is in a financially healthy position, a second mortgage can nevertheless be beneficial.
How Does a Second Mortgage Work?
Unless you have been living in your home for upwards of 3 decades, you likely are still making mortgage payments every month. Until all of these payments are complete, the bank still maintains some of the value of your home, but that does not mean that you carry no entitlement in your home’s value. Home equity is the difference between the market value of your home and the remainder of your loan balance, and this is the value that is technically yours. So, what a second mortgage does is essentially give you access to that value in the form of a loan, where you can spend that value as cash, and then pay back the balance over time.
So, the second mortgage is nearly identical to the first mortgage. Where you have an asset (in this case, your home equity), you take out a loan on that asset, and then over time, you pay back that loan. The main difference is that the first mortgage has priority claims to your collateral, i.e. your house. What this means is that, if you go bankrupt, the lender of the first mortgage will be able to retrieve every last cent of the loan before the second mortgage lender gets anything.
This makes the second mortgage riskier for the lender, and as such they will ask for a greater interest rate. Also, since this is very much just a second version of a mortgage, there are still the typical loans and fees associated with the agreement. But, if you can afford the upfront costs, and are comfortable with the additional leverage now on your home, then this can be an excellent source of funding.
How Can I Structure My Second Mortgage?
Second mortgages can either come as a lump sum of cash (called a Home Equity Loan) or a revolving line of credit (called a Home Equity Line of Credit). Aside from when you actually get the cash, they are different because the lump sum of cash will have a fixed interest rate, whilst the line of credit will have a variable interest rate.
Obviously, a fixed interest rate gives the homebuyer an additional level of certainty and security, as they will understand exactly how much they will need to pay, and how long it will take them to pay it back. A variable rate of interest is, obviously, without this, but in a particularly low interest rate environment, it might mean that you end up paying significantly less.
Your decision will ultimately depend on the nature of your decision to take out the second mortgage. If you are mainly hoping to make one larger purchase just one time, the lump sum could help, but if it is for multiple large payments over a long period of time, then having a revolving line of credit can help you make these payments with lower interest rates than personal loans or other revolving credit facilities.
Is Another Mortgage Worth It?
A second mortgage is a very serious thing, and you should not use this just as a way to gain some extra spending money in the short term. Second mortgages have historically been great tools for debt consolidation, where the equity retrieved from the loan is used to pay down all existing student loan debt, credit card debt, or auto loan debt, and the borrower is now only responsible for the interest payments on the second mortgage. Especially if you can get a lower interest rate on the mortgage, this is a solid way to streamline your finances.
For recurring payments like college tuition or medical bills, having a revolving credit line can also help ease the financial pain that you will be in. Assuming that you can do the math on the amount of interest you will be taking on, this could be a great way to handle this challenging time.
Furthermore, it would be most beneficial if you can use this equity to improve the market value of your home. For example, if you used this money to take on a large home improvement project to spruce up your kitchen, you will likely be able to sell the house at a greater value down the road, thus increasing your return on investment even more on this asset.
No matter what your situation, you need to be careful with your decisions. You should only take out a second mortgage if you are absolutely certain that you can maintain job stability in the future, otherwise you are putting yourself back under a lot of debt that you cannot necessarily afford. Also, again, there are not just the interest payments but the upfront costs associated with taking out a mortgage, which can be very steep, and you need to be able to pay them immediately.
Should I Pursue a Third Mortgage?
A third mortgage would be a possibility in the home improvement example that I used above. If, after 2 mortgages, there is still considerable equity in your home that you would like to borrow, a lender might be willing to give it to you. However, this is only if you have an outstanding credit history, impressive income, and a loan-to-value ratio that, on its own, would garner a favorable first mortgage.
But, if this is something that you can muster, it could possibly be a better option than refinancing your previous two mortgages. Oftentimes, if the interest rate environment encourages you to refinance your mortgages, the prepayments and costs that go along with that can be higher than the costs of a third mortgage. You should always sit down with your lender and discuss the best way to save money, in this situation.
Taking out a second mortgage does not have to be the scariest thing in the world, especially if your house has seen a considerable appreciation in value since you bought it. However, just because your house is more expensive now does not mean that you should automatically take out that second mortgage. If the time is right, and you have large expenses coming up, only then should you go forward with it, and only in bigger emergencies should you even consider a third mortgage. But, for those with amazing credit, these options will still present themselves.