How to take a second mortgage (or home equity loan) without being taken
Laura Bell

Have equity? Own a home? The hype is calling you; daring you to tap your equity dollars and use them for your every whim. If you are tempted to turn in some, or all of your home's equity, for either a traditional second mortgage (a total dollar amount) or a home equity loan (available credit line for which you use only what you need), consider the fine print behind those ads.

If you're going to apply, go for it, but understand the loans' background, what to look for, how to make a wise decision, and most of all, an explanation of what it's going to cost.

Erik Cumliff, senior vice president and general manager, Home Spaces (a subsidiary of LendingTree.com), said, "When it comes to second mortgages (home equity loans), we need to remind consumers that they are dealing with their home equity. The price of default is the loss of their home. With any second mortgage, they should realize what they are getting into. The basic qualification is whether you can afford the payments.

If they wish to borrow for credit consolidation, that's OK, but only as long as they are disciplined enough to destroy the credit cards and not put themselves right back in the position they were originally. Valid reasons for second mortgages are home improvement, which increases the value of the property, children's tuition. Other investing is also logical if you are not facing any potential financial emergencies."

Cumliffe further cautioned that consumers should take their time when filling out applications. (All of that can be done on any lending site these days, as well as lendingtree.com).

Second mortgages earlier on

I remember hearing my mother talking to herself one day about how happy she was that the second mortgage was finally paid. When baby boomers were just young down payments, purchase of a second property or additions to a first home were the major uses of second mortgages.

"Home equity loans differ from the traditional second mortgages in that you may never use the entire line of credit, which is granted to you based on the perceived value of your built-up equity, based on a recent appraisal, minus other mortgages. This is a reusable line of credit," says Victor Benoun, author of "Your Castle; No Hassle."

Additionally, home equity loans are usually at variable rates, whereas, traditional second mortgages are generally fixed, just like the first mortgage often is.

Reliable lenders have not thrown out all loaning guidelines to creditors who own a home. But there is a myriad of deceptive advertising on the subject of equity. Some encourage homeowner to borrow up to 125 percent of their home's appraised.

Now, think about it. Watch real estate statistics for more than a year, and realize that home prices are only guaranteed to do one thing: change. Borrow too much on current value and you may end up with a home that you cannot afford to sell. Say you owe $250,000 on a house that's worth $200,000. If you wanted to sell the house, you'd have maybe $185,000, after Realtor's costs and moving expenses. That means you no longer have a house AND you owe a lender $65,000.

As far as qualifying for a loan, a credible mortgage lender will still boil down to: credit rating, earning power, other consumer debt and value of the home.

If you use the Web to find your deal, realize that unless the site names itself as a mortgage banker, they are only acting as a third party and not actually funding the loan.

It can matter later on to know who funded the loan. It can be quite upsetting to discover that your loan has been resold or that your original lender has been bought out or merged. It can change things like due dates, and whom you pay your monthly bill to.

Costs and rates

Here is where reading the fine print has never been more important. There are costs to every loan. Trying to specifically define them ahead of time is enough to give most of us a headache.

These costs can change. Asking a lender to estimate ahead of time might and might not get you a reliable answer. Mortgage loan costs include: closing costs, appraisals (not always performed these days), credit reports, as well as interest rates, and fees you are paying the lender for the loan (points). Ask for an itemization. Also request specifics on how they might change during the term of the loan application. Demand to be notified if costs change before the day you are scheduled to come and pick up your check, or in some cases, it is mailed to you.

Also, ask how long your mortgage interest is locked in for, from the day of application, while you are awaiting approval.

Define the loan's term

There are a variety of home equity loans as well as full fledged-second mortgages. What type of payment plans are you talking about. Find out how many years the mortgage term is. Be sure to ask if there are any prepayment penalties, and look for one without any (many states don't allow prepayment penalties).

Ask questions about balloon payments if one is a part of the package. Balloon payments give you only three options at the end of the mortgage term, pay up (you might not have it), refinance or sell.

Checking on rates

Most decent sized daily newspapers run a weekly listing of interest rates, often courtesy of Bankrate.com. Also look at the indices of things like government treasury bonds. Find out what index your loan is being based on if you are considering going for an ARM (adjustable rate mortgage, otherwise known as a variable rate). Also find out how often your interest rate is subject to change. (The number of times a lender is able change during a year's time will vary, but will be specified in the loan.)

Interest rates for the term of the loan are going to vary according to what each lender views as his current slot in the market. However, realize that lenders base their final decision not only what they think your risk is, but an index as a measuring tool. For home equity loans, this is the prime rate. For standard second mortgages, this is currently government T-bill rates. All these are subject to change. But keeping an eye on these indices can give you an idea about when the best time is to go for the your second mortgage.

Variables: state of the economy

The price of homes constantly fluctuates. So does the unemployment rate. So do a myriad of other economic variables that can effect whether it is a good time to take out another loan on your home. 

Has the world been rushing to refinance again because interest rates are going down? Sounds good. Is the construction industry way overbooked? That'll make your renovations more expensive. These are just a couple to keep in mind.

Bottom line is that a decision to use the equity in your home for other than what it is doing (acting an investment in a non-liquid form), should be based on more than a need for additional revenue.

How the net has changed the second mortgage market

The Net has changed the mortgage market by making it appear as if this is a risk-free operation. This could hardly be farther from the truth. It has also opened the doors to a floodgate of hype from lenders who want nothing more than your signature on a piece of paper.

The platform for applying, doing your homework, and getting answers has changed, but it doesn't change the fact that second mortgages are putting at risk the home you probably intend to grow old in.

The basics of sound mortgage lending have not and will not change. The Net allows the process to go smoother with speedier approval times and the convenience of not having to visit different lenders.

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