If you have equity in your home, you may be able to borrow against it with a second mortgage loan. You’ll often hear them by the name home equity line of credit, HELOC, and home equity loan. No matter the name, they all do the same thing – tap into your home’s equity. But what price will you pay for this benefit?
The Interest Rate on a Second Mortgage
Generally speaking, you’ll pay a higher interest rate for the second mortgage loan. It’s for good reason. Since it’s a ‘second’ mortgage, it’s a second lien on the home. In other words, the lender is in second position for payment should you default on the loan. If you do default, the chances of the second lienholder receiving payment are pretty slim. The lender makes up for this by charging a slightly higher interest rate than you’d get on your first mortgage loan.
But, if you compare the interest rate on the second loan to the interest you’d pay on a credit card or unsecured loan, it’s probably lower. That’s because these loans don’t have any collateral. There’s nothing guaranteeing your payment. If you default, the only action the lender can take is to send your account to collections or attempt to put a judgment on you.
Different Second Mortgage Loan Options
The type of second mortgage that you take will help determine just how much higher your interest rate will be than your first mortgage. Most borrowers have the following options:
- Home equity line of credit – The HELOC gives you access to a credit line. The lender puts the loan amount in an account and you can use it as you see fit. You don’t have to draw the funds if you don’t’ need them. You also don’t need to make any payments if you don’t draw on the funds. When you do draw funds, you pay interest only for the first 10 years, if you choose to do so. The interest rate on this line of credit is often lower than the home equity loan because they have a variable interest rate. In other words, the rate changes from month-to-month unless you lock in a rate. The introductory rate on the loan is often much lower than a standard loan.
- Home equity loan – If you opt for a lump sum payment, you will pay the price for it. In other words, you’ll have a higher interest rate. The good news is that the rate is usually fixed; it does not adjust. But, you start making the payments right away and that includes principal and interest payments for the next 15 to 20 years.
The interest rate you pay on a second mortgage really depends on your factors, just like any other loan. The higher your credit score and the lower your debt ratio, the better chance you have of securing a lower interest rate. Also, the LTV or loan-to-value ratio of the loan also plays a role. In other words, the less money you owe compared to the value of the home, the better interest rate you may get. The lender bases your rate on your risk level, the less risk you pose, the better your chances of approval.