 Personal Finance PowerPoint Presentation, Second Mortgage. Get ready to get financially fit by practicing personal finance. Most of this information can be found at Investopedia Second Mortgage, which you can find online. Take a look at the references, resources, continue your research from there. This is by Julia Kagan, updated July 31st, 2021. What is a second mortgage? So typically if you're going through a home purchasing process, usually we can't put all the money down upfront. We need some type of financing, some type of loan. That's what we're talking about here. Possibly some situations you might want or need multiple loans in place, hence the second mortgage. So a second mortgage is a type of subordinate mortgage, subordinate to something else, another mortgage. Made while an original mortgage is still in effect. So we don't have a situation where the second mortgage is replacing another mortgage replacing the original mortgage, for example. But now we've got the two mortgages in place. Now remember the one component that gets a little complicated with this, which is why you've got this kind of subordinate item in here, is that when you have the home loans, typically the lender is going to safeguard themselves in the event that you default that you don't pay on the loan by having the loan as collateral so that in that event they can foreclose and so on and so forth. But if you've got two loans from different lenders and something like that, then you've got a situation of, well, who has the primary recourse to the collateral? So it might go then the primary mortgage would have the first recourse most likely then, and then the subordinate would have the second. That doesn't mean that they have no recourse on collateral on the home, but it would be second to the first loan being paid off basically first. So in the event of default, the original mortgage would receive all proceeds from the properties liquidation until it is all paid off. Remember that the lenders don't want to foreclose, they want to get paid on the loan. But clearly they want the collateral there in the event that the loan isn't paid so that they can recoup the loan amount by selling the home. So that would mean that if the first loan, like if you sold the home for $200,000 and the first loan was only $100,000, that would mean the second loan would still have that recourse for the value of the home, for the added value of the home to cover it. But it doesn't have that primary recourse and if there was a decrease in the value of the home, then the second mortgage would be more at risk in that instance than the primary one and that's why it would be subordinate, not as good a position, but still possibly having some benefit from the home as recourse. Since the second mortgage would receive payments only when the first mortgage has been paid off, the interest rate charged for the second mortgage tends to be higher. Why? Because they're taking on more risk and we're talking about a risk versus reward type of situation. So if the bank wants to then sell money because it's a market contract, they want to have the loan, they want to earn interest, but they've got to mitigate that with the possibility that you don't pay the money and therefore they're going to do things like have the collateral and if they're secondary to the capacity to the collateral in the event of something bad happening, you're not paying, then that's going to mean more risk, which means they're going to compensate for that with less favorable terms and the amount borrowed will be lower than that of the first mortgage. So clearly you're going to be able to borrow less typically on the second as well. So using a mortgage calculator is a good resource to budget these costs. How a second mortgage works, what does it mean to take out a second mortgage? When most people purchase a home or property, they take out a home loan from a lending institution that uses the property as collateral. So in the event that there's a default, the property is a collateral. The bank doesn't own the home, the bank can't tell you how to mow your lawn, what color to paint your home and so on. But if you don't pay, then they have the recourse to the home and so it's a little bit different. Keep that distinct in your mind. A lot of people say the bank owns 80% of my home or something like that. That's not technically true. That's someone being a little bit sarcastic in terms of the loan, right? They're kind of overstating the position. What really happens is you've got the home and then you've got a loan which equals 80% of it and the bank has recourse in the event that you don't pay. However, they can't tell you how to use the home unless that happens. So this home loan is called a mortgage or more specifically a first mortgage. The borrower must be repaid the loan in monthly installments made up of a portion of the principal amount and interest payments. So over time, as the homeowner makes good on their monthly payments, the home's value also appreciates economically. So in other words, we could talk about the equity in the home, the difference between the price of the home market price and also the loan value. Two things that you could think about affecting that equity. One, when you're paying down the loan, the amount that's going towards principal is not interest. Interest is like the rent on the use of the money. The principal is going to be paying down the loan that hopefully will increase the gap between the liability, the loan amount and the value of the home, assuming the home stays even in market value. But then of course, we're hoping the home goes up in market value, which is the other factor, another factor that can increase that gap between the market value and the home. Obviously, the home could go down in value, which wouldn't be good, would be less equity happening in that instance. So the difference between the home's current market value and any remaining mortgage payment is called the home equity. So now you're saying, I got home equity, I've got assets, more assets than liabilities. I'm looking good, but possibly you don't have the cash flow at that point because you can't tap into the equity, can't buy your groceries with the equity. So maybe then, maybe then if you need the cash flow, then you could think about tapping into the equity. How can you do that? Maybe a loan or some kind or something happening there, refinance or possibly a second or something. So a homeowner may decide to borrow against their home equity to fund other projects or expenditures like that vacation to the Bahamas. The loan they take out against their home equity is a second mortgage as they already have an outstanding first mortgage. The second mortgage is a lump sum payment made out to the borrower at the beginning of the loan. Like first mortgages, second mortgages must be repaid over a specific term at a fixed or variable interest rate depending on the loan agreement signed with the lender. So you got a similar kind of process, but now you got to think about the equity in the home, possibly for that second loan. So the loan must be paid off first before the borrower can take on another mortgage against his home equity. So using a haylock as a second mortgage, an H-E-L-O-C, haylock, some borrowers use a home equity loan line of credit, a haylock as a second mortgage. A haylock is a revolving line of credit that is guaranteed by the equity in the home. So you might be saying, hey, look, I need like a credit card kind of thing here. You can use my home equity as a collateral for it so I can spend and then repay as I choose. So that's what I'd like to do. So the haylock account is structured like a credit card account in that you can only borrow up to the predetermined amount and make monthly payments on the account depending on how much you currently owe on the loan. So that can give a whole lot more flexibility. If you know exactly how much you need, then it might be cheaper to take out a loan right against it because then you could fix it and the credit card option might be a little bit more expensive in terms of rates and so on possibly. But it gives you that flexibility if you don't know how much you need and you think you'd like to have the capacity to have some cash flow available to you in the event that an emergency happens. As the balance of the loan increases, so will the payments. However, the interest rates on a haylock and second mortgages in general are lower than interest rates on credit cards and unsecured debt. So if you're saying, hey, look, I can do this on my credit card or I can do a haylock, then maybe the haylock is the way to go because of that sec that the credit card doesn't have the support in the event that you default where the haylock does. So you would think the lender would have more favorable terms and therefore give you possibly more favorable terms possibly in the way of lower interest rates. So since the first or purchase mortgage is used as a loan for buying the property many people use second mortgages as loans for large expenditures that may be very difficult to finance. For example, people may take out a second mortgage to fund a child's college education. Whew, those are getting expensive or purchase a new vehicle. Requirements for a second mortgage to qualify for a second mortgage. You will need to meet a few financial requirements. You will need at least a credit score of 620. You got to hit that hurdle again with that credit score we've seen in the past. A debt to income of 43%. And you will need to have a decent amount of equity in your first home. That's the difference between the loan value and the fair value of the home which could have gone up because either you pay down principal on the loan which means you've had it for a substantial amount of time because those first payments are mostly interest. So it takes a while to pay down the principal and hopefully the home went up in value because you were savvy investor and you bought a home that just skyrocketed in market value afterwards and now you just dip it into that by low so high. That's my motto. Because you are using the equity in your home for the second mortgage you will need to have enough not only to take out your second loan but be able to keep approximately 20% of your home's equity in the first mortgage. So they're going to have similar kind of equity requirements. They're probably not going to want to allow you to finance the entire home because then if you default they're going to be at risk there because they want you invested in the home just like with the purchase process. They want you invested in the home meaning it's not completely financed typically and if the market went down then they'd have a problem if the home was completely financed so they still want you to have some equity in there. So special considerations. Let's do some special stuff. Borrowing limits. It may be possible to borrow a hefty amount of money with a second mortgage. Second mortgage loans use your home presumably a significant asset as collateral so the more equity you have in the home the better. So if you got equity in the home that's good stuff because you might be able to tap into it with a mortgage although again it's not as liquid of course as other types of assets. So most lenders will allow you to borrow at least up to 80% of your home's value and some lenders will let you borrow more. You have to borrow enough money to cover your first and second mortgage mortgage as well. So we got the approval time. What's the approval time? Like all mortgages there is a process for obtaining a HELOC or a home equity loan and the timeline may vary. It's not like a magical thing that just kind of happens. You don't snap your fingers you got to go through a process. So you will need to apply for an appraisal of your home will need to be done and it usually takes the lenders underwriter a few weeks to review your application. So clearly they're going to have to determine what is the market price of the home so they can kind of determine how much loan you might be able to pick up on that as one of the factors. So it could be four weeks or it could be longer depending on your circumstances. Second mortgage costs what's the cost of doing this kind of thing. I like the sound of this. How much is it going to cost me? Just like the purchase mortgage there are costs associated with taking a second mortgage. These costs include appraisal fees, costs to run a credit check and origination fees. So obviously these can be significant when you're talking about something as large as the process as the mortgage is not going to be as tedious a process as the original purchase but still somewhat tedious process. Although most second mortgage lenders state that they don't charge closing costs the borrower still must pay closing costs in some way as the cost is included in the total price of taking out a second loan on a home. Since a lender in a second position takes on more risk than one in the first position not all lenders offer a second mortgage. So the second mortgage some people are going to say hey look I don't like being in the subordinate position because I take on more risk I'm not doing it but other lenders will depends on the risk versus the reward analysis of the lender. Those who do offer them take great steps to ensure that the borrower is good to make payments on the loan. So clearly if you're going to be taking on more risk you do your due diligence to make sure the lender has the capacity to make the payments. When considering a borrower's application for a home equity loan the lender will check whether the property has significant equity in the first mortgage a high credit score stable employment history and low debt to income ratio. So we've seen these factors before similar kind of factors as we saw with the first loans. Let's just take a quick look at them once again. So obviously they're going to look at the equity which we've been talking about which could have gone up since the home purchase process happened. Hopefully that's probably why most people might be tapping into that equity. They're like hey I got some equity here why don't I cash that cash that in to buy myself something that I want to buy or something like that. So the equity is going to be a factor clearly because that's going to help them to consider the home still as a legitimate resource in the event that there's a default on the payment. So then we've got the equity in the first mortgage a high credit. So you've got to consider the equity that the first mortgage is going to be eating up and how much remaining equity would be there for the second a high credit score. Clearly the credit score is still going to be a significant factor. The stable employment history. So they're going to be looking at the employment history going back a few years for the employment history. Typically confirming the gross income because that's easier to confirm say than expenses. They can do so with the W to possibly bank statements and with the tax returns. So they'll be taking a look at that more stable types of things they like to see. You would think as a lender you would expect that would be the case if you were the lender. I want to see like a tenured professor who basically couldn't be fired if he did something horrible. Right. They're locked in. They're going to be paid no matter what right what happens. That's what I want to see as the bank. So if you're if you're an hourly employee not so much faith but still might be OK. If you're a sole proprietor then the bank's not really too happy with you oftentimes even if you're doing quite well which is a little disturbing and annoying. You could see why there would be an increased risk to them and where they're coming from on that. So and then of course the debt to income ratio is going to be a critical factor advantages and disadvantages of a second mortgage taking out a second mortgage means you can access a large amount of cash using your home as collateral going to cash in that collateral. It's not always a good idea. So you don't want to use it as a credit card. I'm just kind of joking here but you know that's obviously kind of what people think when there's an increase in the housing market people like to cash in that collateral. So often these loans come with low interest rates plus a tax benefit. You can use second mortgage to finance home improvements pay for higher education costs or consolidate debt. So you want to take into consideration the use of the second mortgage to make sure to determine whether or not there's going to be a tax implication for it or not. So make sure that you're doing your due diligence if the tax consideration is a significant one for the second loan. So the risk of taking out a second mortgage however are not unsubstantial nor inexpensive. So expect to pay closing costs appraisal fees a credit checks during the process and you run the risk of losing your home if you can't make payments. So obviously if you're taking on more debt you got risk involved taking on the more debt. So you want to be doing your due diligence and thinking about the risks versus rewards. What are you using the money for. Is it worthwhile to use to take out the loan to do whatever you need to do with the cash flow or would you be better off keeping that investment in the home. So pro second mortgage allows you to access the untapped equity in your home for cash. The helox and home equity loans can help pay for big ticket items like college or major renovations. Interest rates on second mortgages are lower than on private loans or credit cards. So if you so if you're comparing that to other ways to get financing if you're saying I need financing and I got I can go to the credit card and get a loan from the bank or I have equity in the home then oftentimes the equity in the home is going to give you more better financing terms. If you don't need financing then then you just want to take it out so you can go to the Bahamas or something like that you might want to may not be worth taking on the risk in that case. But you know it's up to you cons. If you can't pay a second mortgage back you risk losing your home. So clearly you know you're taking on debt if you can't pay the debt. There's consequences or usually there is must put past new laws or something removing consequences and then but there'll be consequences to that if they do that. But it'll be weird. So if it costs money to close on a second mortgage so obviously there's going to be some upfront costs to processing the mortgage. If your home doesn't appraise high enough and you don't have enough equity in your home you may not qualify for a second mortgage so you can only do it if you qualify for it. So can you get a second mortgage to buy another house. Yes you can use a home equity line of credit or a home equity loan to purchase a second home. Can you get a second mortgage if you have bad credit. Probably not. Most mortgage loans call for at least a credit score of 620.4 620. So that and obviously the lenders might be a little bit more skeptical on the second because they're losing to have a little bit more risk involved because they're going to be subordinate to the primary loan credit scores possibly being more more significant in their calculation. Then what happens to a second mortgage after foreclosure on the first. So when your first mortgage goes into foreclosure your other light leans including a second mortgage will be removed from the first mortgage. The second mortgage becomes its own entity to be paid back. So what can you do to stop a second mortgage foreclosure. Make sure to pay your loan on time seems kind of obvious to be honest. But and if you find it difficult to make payments contact your lender right away. So clearly if you can't make payments I think that would be the more question. How do I stop the foreclosure. Well you make your mortgage payments. But then of course what if I can't afford the mortgage payments. Well that's when you want to contact the lender and see if you can work something out with the lender. Remember that in the event that that you're going to go into default the lender doesn't want that to happen because they're not in the business of foreclosing. So you might have some leeway with them to come up terms that would be beneficial for both parties considering the situation that we are currently in at that point in time. So you probably don't want to just ignore it and not talk to the lender most likely because then then you know you're not going to be able to look into possible alternatives. You typically want to be up front with the lender and say hey look I got a cash flow problem. I can't pay the bills at what they're at at this point. It is what it is. You know I can I'll show it to you and basically let me know what we can do at this point if there's anything we can do prior or so to defer or not do the foreclosure process and the bank has some incentive to try to work something out at that point. So how do you refinance a second mortgage. Yes you can refinance a home loan or HELOC following basically the same steps you would follow to refinance the first mortgage so you can refinance them A silent second mortgage is simply a second mortgage taken on a home for down payment money but is not disclosed to the original mortgage lender on the first home mortgage. The bottom line. If you qualify for one second mortgages can help you pay for home improvements and major renovations a second down payment on a second home or to help pay for your child's college. They can also be a method to consolidate debt so this would be a method if you look at a finance someone that's trying to consolidate the debt possibly credit card bills and so on using the money from the second mortgage to pay off other sources of outstanding debt. Why would you want to do that possibly because you can get lower rates and so on due to the fact the second mortgage has the collateral possibly then their capacity to get the lower rates which may have carried even higher interest rates so clearly you'd be consolidating the rates hopefully in the consolidation process.