You may be able to draw on your home's equity to get cash ... but should you?
A second mortgage — often called a home equity loan — is an additional mortgage that you have on your home. This additional mortgage essentially allows you to have access to the equity of your property, and, just like your mortgage, your home is used as collateral.
Since property values are on the rise, these mortgages might be something to consider, but how do you know if it’s the right move for you and your family? Here are some pros and cons of taking out a second mortgage.
- Quick access to cash with favorable interest rates. The biggest pro to taking out a second mortgage is the ability to access cash at a great rate (especially in comparison to most credit cards). Taking out a second mortgage could help you with a variety of expenses, such as small business startup costs or tuition for your college-bound kid. This can be a great option for those who have a smaller savings account, or for those who don’t want to dip too much into savings for large purchases.
- Ability to take on home improvement projects. Whether the renovation bug has bitten you, or your home is in dire need of some updating, a second mortgage is a great way to get money to quickly tackle a bunch of renovations all at once. Not only will you get your projects done fast, but you’ll also further increase the equity of your home. So go ahead and pick out those subway tiles and the perfect quartz countertops.
- Fees associated with taking out a second mortgage. While you may be getting a large amount of money with your second mortgage, this does not come without a cost. Appraisal fees, application costs and closing costsassociated with a second mortgage can get hefty, which is something to think over if you are considering taking one out. An alternative to a home equity loan is a home equity line of credit, or HELOC. Just like a home equity loan, your home is used as collateral for a HELOC. But you’ll get a credit line, similar to a credit card, rather than the lump sum payment you’d get with a home equity loan. The interest rates are typically higher with a HELOC, but it does not require closing costs.
- Risking your home. Though interest rates on second mortgages are typically lower than credit cards, those lower rates come with a higher risk. When you take out a second mortgage you are risking your home, which means that if you can’t pay the loan back, then your lender can foreclose. To mitigate the risk of losing such an important asset, be sure to really analyze how much money you have available to you each month before you take out a second mortgage.
- Frivolous spending can lead to more debt. When you take out a second mortgage, there are few restrictions on what you can spend the money on. While this money can be extremely helpful in many ways, it can also be harmful if you choose to spend money on nonessentials, because it leads to more debt. Before you take out the loan, thoroughly consider what exactly you need the money for, and if the purchases are worth the risk. In other words, buying a closet filled with designer shoes may not be the best use of a second mortgage.
Second mortgages can come with potential risk, but if you make sure that you’re using the funds appropriately, they can be a great way to put your equity to good use. Always be sure to consult with a financial adviser to see if a second mortgage is appropriate for you.