Using the equity in your home to make home improvements or pay off unsecured debt can be a hard decision. Low annual percentage rates, tax-deductible interest, and streamlining your monthly payment
Second mortgages come in two basic forms: home equity loans and home equity lines of credit, or HELOC.
Home Equity Loans
With a Home Equity Loan , you receive the entire amount of the loan in a lump sum at the time of closing. The repayment term is usually a fixed period, typically from five to 20 years. Usually the payment schedule calls for equal payments that will pay off the entire loan within that time. You are not required to borrow the full amount, but can instead borrow only what you need. Interest rates are usually fixed rather than variable.
A home equity loan is a good option if you need a set amount for a specific purpose, such as an addition to your home, or to pay off your entire unsecured debt.
Home Equity Line of Credit
A HELOC is a form of revolving credit. A specific amount of credit is set by taking a percentage of the appraised value of the home and subtracting the balance owed on the existing mortgage. Income, debts, other financial obligations, and credit history are also factors in determining the credit line.
Interest is usually variable rather than fixed. However, the repayment term is usually fixed.
The advantage of a home equity line of credit is that you can take out relatively small sums periodically, and interest will only be charged when you deduct the money.
Is a second mortgage a good idea?
Before you decide which type of second mortgage is best for you, first determine if you really need one. Here are a few questions you may want to ask yourself:
- Do you frequently use credit cards to pay for household bills?
- If you subtract your expenses from your income, is there a deficit?
- If you were to pay off your creditors by using the equity in your home, would there be a strong possibility of incurring more unsecured debt?
If you responded “yes” to any of the preceding questions, using the equity in your home to pay off consumer debt may be a short-term solution and may not be your best option. Spending more than you make is never a good reason to use the equity in your home.
Factors to consider
One factor to consider when shopping for a second mortgage is closing costs, which can include loan points and application, origination, title search, appraisal, credit check, notary and legal fees.
Another decision is whether you want a fixed or variable interest rate. If you choose a variable rate loan, find out how much the interest rate can change over the life of the loan and if there is a cap that will prevent the rate from exceeding a certain amount.
An integral part of the loan process is shopping around for the lowest APR (Annual Percentage Rate) to get the most value out of your second mortgage.
The APR for home equity loans and home equity lines are calculated differently, and side by side comparisons are not necessarily like-for-like.
For traditional home equity loans, the APR includes points and other finance charges, while the APR for a home equity line is based solely on the periodic interest rate.
How do I get started?
If you have decided that using home equity is a sensible choice, your next step is to understand the process of obtaining a second mortgage and choose between a home equity loan and a HELOC.
Before you make any decision, compare the APR, closing costs, loan terms, and monthly payments. Also inquire about balloon payments, prepayment penalties, punitive interest rates in the event of default, and inclusion of credit insurance.