Home Loan Options: Second Mortgages And Home Equity Loans

Second mortgages and home equity loans allow you to make the most of your home's value""without selling your home.

Second mortgages and home equity loans allow you to make the most of your home's value""without selling your home. Loans secured by real estate generally are considered safer by lenders, resulting in lower interest rates than are available with other types of loans.

Second Mortgages

First things first: A first mortgage is a loan secured by a home that has no other mortgage against it. It is generally the loan you take out to purchase or refinance the home. A second mortgage is simply a loan secured by a home that already has a first mortgage (or a tax lien) in place. Homeowners often obtain second mortgages to finance home improvements. The loan is constructed simply as another mortgage.

The interest rate is generally higher on a second mortgage than on a first because of increased risk""another lender is already in line to foreclose on the house should the borrower default on the mortgages.

Home Equity Loans

A home equity loan is a financial product that allows a borrower to use the home as collateral for a loan. Loan proceeds can be used for any purpose, such as paying off other, higher interest debt, financing education costs, or making improvements to the home.

Home Equity Defined

Basically, your home's equity is determined by taking the current market value of your home and subtracting any other mortgages or liens secured by the home. For example, if a house with a market value of $100,000 has an outstanding mortgage of $30,000, the homeowner has equity of $70,000. If there were no mortgage or other type of lien on the house, the homeowner would have $100,000 in equity.

The longer the mortgage term, the longer is required to build up substantial equity. During the first several years of a 30-year loan, almost all of each monthly payment is applied to the interest, not to the principal amount.

Home Equity Loan Position

A home equity loan can be considered either a first or second mortgage. If you are still paying on your first mortgage, then a home equity loan will be considered a second mortgage. If you own your home outright and take out a home equity loan, it will be considered a first mortgage because it is first in line to receive payment if the home is sold or a borrower defaults. Note that if you refinance an existing first mortgage, and pledge some of your equity to receive cash in hand, you will still have just one--but larger--first mortgage. In this type of loan arrangement, generally called a "cash out re-fi," the dollar difference between the original mortgage and the refinanced mortgage is the home equity loan amount.

Interest rates for home equity loans are determined by competition among creditors and the borrower's own credit history. Market competition and conditions determine the rates in general; the borrower's own credit history will further effect the rate offered.

Proceed with Caution

A home equity loan offers some tremendous benefits to a homeowner. If you have a huge pile of credit card debt, refinancing that debt using your home equity can save you a lot of cash and may even be tax-deductible. But what if you lack the discipline to cut up those credit cards and charge them all back up again? You could get in over your head""and end up losing your home. Before you offer your home as collateral for another loan, think hard about how your spending habits might have to change to keep a home equity loan from taking advantage of you.

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