|By David Pilley on April 5, 2011
After paying on a mortgage for a few years, your home gains equity. A popular action to take may be getting a second mortgage, or a loan secured against your home’s equity. Some reasons to get a second mortgage include home improvements, creating a home equity line of credit (HELOC), avoiding private mortgage insurance, or for loan consolidation. Here are some of the positives and negative for getting a second mortgage.
If you get a HELOC, it is similar to another credit card. If you consolidate your credit card debts into a HELOC, there will be a substantially lower interest rate, meaning you could save a few hundred dollars on your entire debt repayment. The interest rate on a HELOC is higher than the interest rate on your mortgage, but again it is lower than the interest rates on your credit cards, an appealing reason to consolidate your cards. A drawback to this is, while you may have lower monthly payments and a lower interest rate, you may have to make a balloon payment at the end of the loan’s term. If you can’t make this balloon payment, you will obviously be in more debt, and the cycle will continue.
While a HELOC is flexible, meaning you can tap into it at any time to use its funds, and the interest rate is lower than your credit cards’ rates, the rate is not permanent. It is controlled by the prime rate, so the amount of interest you pay may change from month to month. It won’t ever be in the double digit percentages, but you might not be comfortable with a volatile interest rate. It is possible to get a fixed-rate HELOC, but you can’t access this line of credit whenever you need it.
A popular reason to get a second mortgage is tax deductibility. On balances less than $100,000, interest paid on a second mortgage is tax-deductible. Not only would you be paying less in interest, you will also have less taxes to pay. I’m 100% sure everybody wants to pay less on taxes.
Contrast the positive of tax deductibility to the ultimate negative: foreclosure. If you can’t make monthly payments on the second mortgage, the equity of your home is collateral. It is possible your lender (or both of them) will penalize you by threatening foreclosure. Not only are you putting your home’s equity on the line with a second mortgage, you’re also putting the property at risk.
To get a second mortgage, you need a good credit score, low debt-to-income ratio, and a strong employment history. You can get one for debt consolidation purposes, but only if you are confident you can make timely payments. If you can’t do this, you might lose your home.