Tough economic times are hitting consumers hard. As fuel prices rise, people are looking for different ways to drum up cash. One method to consider is the second mortgage, a flexible loan that can be used for a variety of different reasons.
When the going gets tough, the tough start borrowing. To get themselves through difficult financial times, more homeowners are considering taking out second mortgages. Consider this overview of second mortgages as you make your borrowing decisions.
Second mortgage defined
A second mortgage is a lien on your home. It's called a second mortgage because, in the event you were to file bankruptcy and the bank was forced to foreclose on your property, the lender holding the first mortgage would be the first to receive any money from the subsequent sale of your home. The second mortgage is, therefore, considered a riskier loan by lenders, and therefore carries a slightly higher interest rate.
Like a first mortgage, the amount of a second is based on the equity in your home. If your property is worth $100,000, for example, and you have a first mortgage for $80,000, a lender could potentially offer you a second mortgage for the remaining $20,000.
Using a second mortgage
Second mortgages can be used in a variety of different ways. However you use the loan, though, it's still debt. It should only be used as a tool to promote financial growth, and not as an easy source of cash for good times.
If you're going to use a second mortgage to improve your home or to launch a business, you're using the money on an investment that will pay back the cost of the loan over time. Use it for a vacation, though, and there's no potential to recoup the funds, unless you happen to find sunken treasure while you're snorkeling in Cozumel.
Loan or line of credit?
Borrowers can choose from two types of second mortgages: The home equity line of credit (HELOC) and the home equity loan. The HELOC works much like a credit card. A homeowner is extended a line of credit based on the equity of his home, and he only pays interest on the amount borrowed. The interest rate on the HELOC is variable and tied to certain market index rates, which makes it more volatile than the home equity loan.
A home equity loan is a set loan amount, locked in at a set rate for a fixed term. You don't have the volatility of the variable rate, but you also don't have the credit line flexibility of a HELOC. Both loans feature tax deductible interest.
Home equity can be a source of capital to help you through recessionary times, if used wisely. Be sure to use a second mortgage only to help you grow a business or improve your home. The smart borrower knows that when the going gets tough, the tough don't use a second mortgage to go on vacation.
