Financing a home can be a very confusing proposition. There are literally hundreds of mortgage programs and rate combinations available: fixed rates, ARMs, buydowns and more. Even more confusing, many consumers may not know that they can purchase or refinance using more than one loan against the property.
There is no way we will have the time to discuss all the financing alternatives available. This report will deal with the second mortgage alternative—namely when is a second more advantageous than having just one mortgage on your property?
When you don’t need to borrow much. Suppose you need $20,000 to finance your child’s education. If your present mortgage is $200,000 and the rate is near the present market, there is no reason to incur the costs necessary to borrow $220,000. Many of the costs of borrowing are a factor of the loan amount. For example, a point is one percent of the loan amount. If you were to incur two points in refinancing, these points would total $4400—an astronomical sum for one receiving $20,000 in benefits. If your first mortgage had a high interest rate and the costs were incurred to achieve a lower rate on $220,000, our advice would be different in this regard.
To achieve conforming rates or guidelines. Conforming mortgage limits are the maximum mortgage amounts that Fannie Mae and Freddie Mac can purchase. Especially with regard to fixed rates, mortgages greater than conforming limits may contain a slightly higher interest rate or more stringent guidelines, such as a larger down payment. Borrowing slightly more than these limits? Why pay a higher rate on the total loan, when you can achieve a lower rate on the majority of the mortgage by adding a small second mortgage?
To avoid paying mortgage insurance. Mortgage insurance protects the lender (not the borrower) from the possibility that the loan is not repaid. Mortgage insurance is usually required for conventional loans with a down payment less than 20% of the sales price. If one were purchasing a home for $300,000, the purchaser would have to pay mortgage insurance if he or she borrowed more than $240,000. When the minimum down payment is being made (five percent of the sales price) avoidance of mortgage insurance payments may be a bit more complex. However, if one were putting 15% down, it would make sense to use a second mortgage so that the first mortgage was less than 80% of the sales price (otherwise known as 80% loan-to-value, or LTV). In this case, paying a mortgage insurance premium on the entire loan amount does not make sense as compared to taking a second mortgage.
To purchase with an assumption. FHA and VA mortgages can still be assumed at their present rate of interest, though credit approval is required. If a second mortgage is placed on the property at the time of assumption, the down payment will be smaller. The owner may be willing to take back a second mortgage to facilitate the assumption if a commercial second is not available.
To help with future monetary needs. Most of us do not know when we might need an infusion of cash. Many second mortgages are available as open lines of credit which can be used at the convenience of the homeowner. One might open a line of credit for $50,000 that would be ready any time we had a fiscal emergency or it would make sense to borrow against the home rather than through other sources.
Advantages of borrowing in this manner might include a lower interest rate or tax deductibility* of the payments of the home equity line of credit. Also having the line available may make it easier for you to pay your first mortgage off more quickly as you will in essence not need as much cash available for emergencies because the line is there. Why not put the money you have in checking and savings to work for you instead of it just sitting there?
Each individual situation will vary, therefore our advice is to visit your lender if you have questions as to whether a second mortgage is a viable alternative for your needs.
*You are advised to speak to your tax advisor before assuming a second mortgage is deductible.
