Let me share a cautionary tale about taking out a second mortgage. I got into a lot of financial trouble in my early twenties. Even though I bought my first home on my own at 23, my finances were a mess and I was stuck in a big-time credit card debt trap. My only saviour was the small bit of equity that built up in my home (I had put 10 percent down on my purchase).
I knew the bank wouldn’t lend me any more money. I needed 25 percent equity for the bank to even consider a home equity line of credit, and my less than stellar credit score didn’t help.
Alternative lenders such as Home Trust and Wells Fargo were offering consolidation loans at 8 percent interest and their lending criteria was much looser – I only needed 10-15 percent equity in my home to qualify. So I added up all of my outstanding high interest rate debt and placed a second mortgage on my home to consolidate those loans into one low(er) interest rate and payment.
Taking Out A Second Mortgage
A second mortgage is just like it sounds – a loan against a property that already has an existing mortgage in place. Interest rates are much higher with a second mortgage because of the risk involved in being second in line. The first mortgage gets priority if a homeowner defaults on his or her payments.
Someone with a good credit score and a lot of equity built up in their house could set-up a home equity line of credit with little trouble and access the funds for a renovation, vacation, or to consolidate other debts.
In my case I had neither good credit nor much equity in my home and so I had to resort to an alternative lender to set up a second mortgage and bail me out of my credit card trap. I paid a little more than $800 per month over a three-year term.
In addition to trust companies, private lenders will also finance second mortgages for borrowers who are turned down by banks and other lending institutions.
The pitfall with any consolidation loan or second mortgage is that the borrower uses the loan to pay off his or her credit cards and then proceeds to rack up the cards again and borrow even more.
Thankfully that didn’t happen with my story, as I managed to dig my way out of that $30,000 mistake and get back on my feet. The monthly payments forced more financial discipline on my part and the sheer embarrassment of having resorted to an alternative lender and second mortgage was enough to scare me straight.
As with any loan, you’ll have to show proof of steady and dependable income to qualify. The higher your credit score, the better your chances at a decent interest rate. And finally, the more equity you have in your home, the better chance of qualifying for a second mortgage.
We all make dumb financial decisions at some point in our lives. In my case, poor spending habits in my early twenties led to some big time money problems in the few years before I turned 30. I got my act together and used a second mortgage to bail myself out of a bad situation. It’s not a great solution for everyone, but I’d say I’ve turned over a new leaf, and then some.
A second mortgage can be a good alternative for those with poor credit and not enough home equity to qualify for a traditional home equity line of credit. Just be sure not to fall back into the debt cycle and dig yourself into an even bigger hole.
Make a plan to pay off the second mortgage as quickly as your budget allows, and put those credit cards on ice.