LOVELAND – You’ve heard the terms first mortgages, second mortgages and home equity lines, but what do they really mean? These terms can be particularly confusing for first time home buyers who imagine having two full mortgages on a home. But, that’s not actually what it means. Here’s a quick explanation of the terms.
First mortgages are exactly what the words imply. They are the primary mortgage on your home. You normally obtain this when you first buy a home. First mortgages are first in line to be paid off when you refinance, sell or default on
In some cases, you may be looking to borrow more money to access the equity in your home. Your options are to refinance the first mortgage and borrow a higher dollar amount, or you may choose to obtain a second mortgage. Typically, you are limited on what you can borrow on a second mortgage. Most lenders will only approve a second mortgage for up to 80% of the value of the home, with the first mortgage included. What does this mean? Let’s run through an example. Imagine your home is worth $300,000. 80% of that value is $240,000. If the balance on your first mortgage is $200,000, that leaves only $40,000 available to be borrowed against with a second mortgage.
As you can see, a second mortgage doesn’t allow you to overlap with the first and borrow twice as much as your home is worth. It’s merely an additional mortgage that may allow you to borrow against your equity in the home.
Why a second mortgage instead of a new loan?
You may be wondering why someone would obtain a second mortgage instead of refinancing their first mortgage for a higher amount. Here’s a possible reason. If the interest rate on the first mortgage is extremely low, you wouldn’t want to refinance the entire loan into a higher interest rate. It would cost less to keep the first mortgage (at the low rate) and obtain the second mortgage (for a smaller dollar amount but at a higher rate).
Simultaneous first and second mortgages
In the past, lenders would allow you to obtain a first and second mortgage at the same time (when purchasing a home). The first mortgage would be for 80% of the home’s value and the second for up to 20%. This was a way to avoid PMI on the first mortgage. Unfortunately, this is no longer a common offering.
Second mortgages versus home equity lines
Second mortgages are similar to home equity lines in that the limit for all loans combined would not exceed 80% of the home’s value. Where they differ is the structure and flexibility.
A second mortgage has a defined interest rate and set length of time for repayment. Additionally, the total amount borrowed would be given to you as a lump sum when the loan closes.
Home equity lines are more flexible. They are normally “credit lines” that you can withdraw from when needed. You could end up taking out smaller amounts of different increments and at different times (until you reach the limit). Additionally, the interest rate is normally variable and calculated against only the current amount withdrawn.
So, there you have it. Now that you know the difference between these mortgage terms, you can better evaluate your options when it comes to buying a home or needing to borrow against your equity.
By Suzanne Plewes, RE/MAX Alliance in Loveland. Suzanne Plewes is a broker associate at RE/MAX Alliance. Write to 750 W. Eisenhower Blvd., Loveland, CO 80537, call 970.290.0373 or e-mail firstname.lastname@example.org.