Pros and Cons of a Second Mortgage, and How to Get One with Bad Credit
A second mortgage is exactly what it sounds like. It’s a second loan, secured by your home, that borrows from the equity earned since you purchased the property. Homeowners may consider taking out a second mortgage when they need a lump sum of money and the option is financially manageable.
Why Take on a Second Mortgage?
As the market changes, home values change with it. Likewise, as you make improvements to your home, the value of it increases. These value increases are called equity, and a second mortgage gives you access to that equity in the form of a loan or line of credit.
Second mortgages are secured by your home just like your primary mortgage, which means if you cannot pay your loan back, the bank can take your house. Homeowners often use second mortgages for large expenses such as funding home improvements, purchasing additional properties, or paying off large debts.
A second mortgage is different from refinancing – which is replacing your existing mortgage with a new one. Both can offer improved rates, but a second mortgage will come with new expenses.
Pros and Cons of a Second Mortgage
Second mortgage loans offer higher loan amounts than traditional loans, with less restrictions on how you spend the money. They also tend to offer lower interest rates than credit cards and when interest rates are low, they can be very manageable from a budget perspective.
However, the nature of a second mortgage puts your home at an increased risk. They require their own closing costs and are accompanied by new monthly payments which will impact day-to-day spending. Finally, while lower than traditional lines of credit, interest rates are typically higher than those associated with refinancing.
Getting a Second Mortgage with Poor Credit
Like with most lending, the ability to get a second mortgage will depend on your current financial situation, as well as your home equity and loan-to-value ratio. While you can get a second mortgage from a different lender than your primary mortgage, your eligibility for borrowing is still impacted by your credit score. Additionally, you will only have access to 80-85% of your total home equity.
The typical requirements are that you must have equity in your home, have a credit score of 620 or higher, and have a debt-to-income (DTI) ratio of 43% or lower. However, as with any loan, there are options if you don’t fit within those parameters.
If you are a homeowner with poor credit should always start by bolstering their credit habits. This means making the best credit decisions possible: do not take out new lines of credit, improve payment habits, and avoid accumulating new debts. Try pursuing non-traditional lenders, such as minor banks, and be prepared to explain any problematic payment habits of the past. Finally, a co-signer can make or break the opportunity for someone with poor credit, as they agree to be responsible for the loan if the primary recipient defaults.
Second mortgages are a unique financial option that allow homeowners access to their home equity. As with all financial decisions, they come with risks and rewards to consider. However, if you have equity to borrow and are prepared for the extra responsibility, a second mortgage can make big things possible – like buying a vacation home.