ShareDoes a client want to renovate their home or add a feature like a swimming pool? A second mortgage can be a source of funds for home improvements and many other purposes. Home equity loans or home equity lines of credit (HELOC) are considered the major second mortgages that real estate agents should know about. A second mortgage can help your client tap into home equity to access funds even if they haven't paid off their mortgage in full.
What Is a Second Mortgage?
A second mortgage is a secured loan that lets borrowers use the equity they have in their home as collateral, even if they already have a mortgage.
Home equity refers to how much ownership a homeowner has in their home. For instance, someone who has paid off their mortgage already owns their home outright and has 100% equity. Borrowers with active mortgages can easily calculate their home equity by subtracting the amount they owe on their mortgage from the home's appraised value. Most second mortgage lenders will issue loans equal to a percent (typically 80%) of the equity value.
Sometimes called a junior lien, a second mortgage can be used for almost anything, from home renovation to debt consolidation. However, it's important to help clients understand that there are risks associated with using their house as collateral. Failure to repay the loan means they may lose their house. In case of a foreclosure and sale at auction, the primary mortgage lender will take the major share of the sale while the second mortgage lender will receive the rest.
There are two key types of second mortgages:
- Home Equity Loan: Home equity loan borrowers receive a lump sum payment and typically have a fixed interest rate.
- Home Equity Line of Credit (HELOC): Borrowers are granted access to a line of credit, and they can make as many or as few withdrawals as they want up to a maximum available amount.
What both loans have in common is that they can take anywhere from between a couple of weeks to two months to process. They also carry closing costs, usually ranging from 2% to 5%.
Leveraging Second Mortgages
Homeowners getting a second mortgage can reinvest their loan into their home, or they can use their home equity to fund other investments or purchases. Here are some common reasons why people get home equity loans or lines of credit.
Second Mortgage for Home Renovations
Using a second mortgage to reinvest in one's own home often includes adding improvements to boost resale value. As an agent, you can explain the best ways for homeowners to maximize their return on investment through smart renovations. NAR Remodeling Impact Report suggests that working on floors and roofing could be beneficial for homeowners. According to the estimates in the report, refinishing hardwood floors could help homeowners recover 147% of their costs, while installing new wood flooring could bring in 118% of their investment. New roofing, insulation upgrades, and new garage doors also recovered the full investment.
Second Mortgages to Tap Into Equity
A second mortgage allows homeowners to unlock their home equity and use it strategically. Homeowners may use a junior lien as part of a debt consolidation strategy, but it's a good idea to look out for favorable second mortgage rates. A home equity loan or line of credit can also help pay for higher education, medical bills, or other big-ticket expenses. For some homeowners, a home equity loan can help fund investments in real estate, stocks and bonds, or mutual funds. In every situation, borrowers should consider the second mortgage interest rates available to them before deciding.
Potential Risks of Second Mortgages
Homeowners should understand the risks of a second mortgage before applying for one. A home equity loan or line of credit may have the following disadvantages:
Second Mortgages Result in Multiple Liens
Second mortgage lenders place a second lien on the borrower's house. Defaulting on a home equity loan or line of credit can lead to foreclosure. Once the home is sold, the primary lender typically receives their dues first. If there isn't enough money left over from the sale to pay the second mortgage lender, the lender may take legal action to garnish the borrower's wages or place liens on the borrower's personal property.
A Second Mortgage May Create Property Ownership Issues
Both primary and secondary mortgage lenders place liens on a home to secure the loan they've issued. When a lien is present on a home, the borrower's legal ownership is not clear. They technically don't have complete legal ownership of their home since their lenders are entitled to seize and sell the home if the borrower can't make payments. This title issue can make the home much harder to sell or refinance.
Home Equity Can Fluctuate
Changes in the housing market can affect a home's value. Your client's home may decrease in value for any reason (market fluctuations, age, disrepair, or other damage to the home), but their second mortgage debt still stays the same. A decline in equity value means that homeowners may end up paying more in loans than the house is worth.
Short- and Long-Term Financial Impacts
Here are two major long and short-term considerations for homeowners before applying for a second mortgage:
- Risk of losing the house: With any secured loan, the lender can seize the collateral if the borrower can't repay the loan. For a homeowner, this could mean losing their place of residence should they be unable to make payments.
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Increased debt burden: Understanding second mortgage rates is crucial because agreeing to a high rate in a bid to consolidate debt may increase the borrower's overall debt burden.
Strategies for Agents: Guiding Clients in Second Mortgage Decisions
There are several best practices that real estate professionals can use to assist clients in making informed decisions about second mortgages. Here are a few to consider.
Assess Financial Health
Second mortgage borrowers must make minimum monthly payments on their debt. Agents can help clients determine if they're financially capable of this commitment. HELOCs and home equity loans may also carry other costs (application fees, closing costs etc.) that borrowers must pay upfront. It helps to give clients a breakdown of the long- and short-term costs they should expect when taking on a second mortgage.
Identify Value-Adding Projects
Clients may have many home upgrades in mind, but not all of them will offer a great return on investment. As an agent, you're well placed to steer them toward remodeling projects and other home improvements that can add long-term value while also making the home more comfortable for the current residents.
Budget Planning
Home improvements can go over budget for many reasons. From delays caused by bad weather or supply chain issues to uncovering issues like water damage or mold that require additional work – costs can rack up quickly. An agent can help clients create a budget with enough room to cover any unanticipated expenses.
Review Loan Options
Real estate agents and REALTORS®, members of the National Association of REALTORS®, can use industry knowledge to help clients review and compare second mortgages to find the best rates and terms. Talk to clients about potential fees and discuss prequalification to help them find the best option available.
Timing Considerations
Timing plays a major role in the success of a second mortgage. A real estate professional may know that market fluctuations influence the value of the owner's equity as well as the rates available to them. A weak credit score and an existing mortgage also impact the loan rates and terms a borrower can get. If the timing isn't good for a second mortgage, other options like a cash-out refinance or a blended mortgage could prove useful.
Second Mortgages: Opportunities and Risks
Real estate agents must continuously educate themselves about the evolving landscape of second mortgages to better serve their clients. Tailoring recommendations based on each client's unique financial goals and circumstances helps them make the right decision, but it's also important to keep market trends and fluctuations in mind and anticipate how they may impact clients in the long run.