What is a Second Mortgage?
You've probably heard someone, perhaps a friend or neighbor, talk about taking out a second mortgage. You may be wondering what this means.
The technical term for this sort of loan is a home equity loan. It is a loan against the equity you have built up in your home as the result of making your monthly payments on your regular mortgage or by its appreciation in value. That means that you are pledging your home as collateral against the repayment of the loan, just like you do when you take out a normal home loan. It means that the interest you pay on it can be deducted from your income taxes, but it also means that if you stop making your monthly payments, your home can be foreclosed upon in order to satisfy the loan.
There are a number of different kinds of home equity loans, but they all group into two basic types: closed-ended and revolving. The closed-ended loan gives you a large lump sum of money when you contract the loan, and in return you make monthly payments for the next fifteen years. Until you have paid off the loan in full, you cannot contract another loan against your house.
By contrast, the revolving home equity loan, usually called a home equity line of credit or HELOC, is something you can dip into at need, up to your credit limit. Your monthly payment will depend on how much of your line of credit you are using at any given time. Typically you will be given a book of checks that look very much like your regular checkbook, so that when you take money out of your HELOC you can either write a check directly to the business you are paying or write a check to deposit in your regular checking account.
The closed-end home equity loan gives you a large amount of money up front, so it is often used for major home renovations and other expenses that come in one large lump sum. By contrast, a HELOC gives you the flexibility to dip into your home's equity as you need it, for instance to cover unexpected emergency expenses like major home repairs that can't wait for you to set up a regular loan. If your furnace goes out in the dead of winter or if your sewer line suddenly fills with tree roots and sends raw sewage backing up in your bathrooms, you want to be able to get people working on it right away, without having to spend days getting financing arranged.
Setting up either form of home equity loan will involve working with a loan officer at your lending institution. The size of your home equity loan will depend upon the appraised value of your home (which will usually involve having to have someone come out and look at it, so you'll want your home looking its best), your income, and your credit rating.
Because you are pledging your home as collateral for your home equity loan, you will want to think very carefully about why you are taking this money out and how you will repay it. Many of the people who lost their homes as a result of the 2008 housing crisis had repeatedly cashed out equity on their homes and used it for frivolous consumption like expensive vacations and fancy cars rather than a college education that would improve their earning power or home improvements that would increase their home's real value. Often this equity was not real progress on repaying their original mortgages, but was only paper value that resulted from rampant speculation on housing in their markets, a paper value which vanished when the housing bubble inevitably burst, leaving them owing far more on their homes than they could possibly realize by selling them.
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