Second mortgages, which tap the equity in your home, aren’t free money. But they provide borrowers with cash that can be used for a wide variety of purposes.
Homebuyers use second mortgages to purchase homes without the need to pay for mortgage insurance. Homeowners use second mortgages to pay for home repairs or improvements, finance a college education or meet other financial expenses.
There are two basic types of second mortgages:
- The traditional second mortgage, also called a home equity loan, generally has a set term of 15 or 30 years and a fixed or adjustable mortgage rate.
- The home equity line of credit, or HELOC, works more like a credit card with no set term and a variable interest rate.
Qualification guidelines for second mortgages
The most important requirement to qualify for a second mortgage is equity in your home. Equity is defined as the current fair market value of the home minus the amount owed on the outstanding mortgages.
For example, if your home was worth $220,000 and the balance on your mortgage was $200,000, your equity would be $20,000, or 9 percent, of the value.
If your home was worth $220,000 and the balance on your mortgage was $250,000, your equity would be negative, or essentially zero. Borrowers who have no equity can’t qualify for second mortgages.
Bankrate’s home equity calculator can help you figure out how much equity you have in your home.
Even if you have equity, you’ll also need adequate income to pay your debts and other financial obligations and a reasonable credit score to qualify for a second mortgage. Borrowers who have a big cushion in their monthly income and a high credit score can qualify more easily for second mortgages.
Second mortgages borrow against equity
Second mortgages are loans against the value of your home. That means if you don’t make the payments on the second mortgage, you could lose your home to the lender.
Second mortgages also can be problematic if you want to refinance, need a loan modification or have to sell your home for less than the amount you owe on your mortgages in what’s called a “short sale.”
Bankrate’s mortgage loan-to-value calculator can help you figure out if you have equity in your home and your combined loan-to-value ratio, or CLTV.