Going for a second mortgage and managing it may not be tough if you've already taken a loan against your home. However, there are loopholes which you would surely like to avoid. So, prior to moving on with a second loan, take a look at the 10 big mistakes which can spoil your deal and make things worse for you.
1. Not being aware of Home equity loans and Helocs
Home equity loans and Helocs are both second mortgages taken against your home equity. But one is a fixed rate loan mostly while the other is an adjustable rate loan. Besides, the former allows you to take the loan funds at a single payment, the latter offers the credit line option wherein you can get advances till you don't exceed the available credit limit. Moreover, the purpose of these loans are different, for example, you consolidate debts with equity loan or go for home improvement but when it comes to periodic needs, it's the credit line that you opt for. So, all you need is a basic understanding of both loans to make them work for you.
2. Taking out a large credit line
Think twice before you take out a large credit line. The credit line will be taken into account when you apply for other loan and possibly you can get rejected too. Most often your credit line payments are determined on the basis of total credit liability even though there may be zero balance on your credit line. As such, a large credit line implies large payments which may affect your ability of repaying the second mortgage or other loans as well.
3. Not shopping enough for the best loan
You may decide to take out the loan from a bank where you have a checking account. But if you wish to get the best loan for your needs, look out for one which can give you some benefits and help you save due to lower rate of interest. Hence, shop around with some lenders/brokers as well as they can provide you with a wide range of offers to compare and choose the best out of all.
4. Not asking for Good Faith Estimate
It's your lender's responsibility to provide you with a Good Faith estimate (GFE) after you apply. It helps you with a breakdown of the fees involved. So, you can be assured of not paying hidden fees and costs. So, even if your lenders forget, just remind him that you are yet to receive the GFE.
5. Thinking a Second Mortgage costs you less
You may have to pay less on a second mortgage than if you are managing a credit card. To know which is better, you need to consider the interest rate on credit card and the effective rate on second mortgage after taking into account the tax deduction. Say for example, you have taken a Heloc. Its effective rate is given by, Effective rate = rate* (1 - tax bracket) If your tax bracket is 30% and the actual rate on the credit line is 15%, then, Effective rate is = 15% * (1 - 0.3) = 15% * 0.7 = 10.5% Now, if your credit card interest rate is higher than 10.5%, then the second mortgage will be cheaper to manage.
6. Going for second mortgage when you plan to Refinance
Lenders may not allow for a first mortgage refinance when you already have a second loan on the same property. They may look out for the combined loan amount even if you refinance only the first loan. Lenders may either ask you to pay off both the loans completely or pay down the second loan when you refinance. However, they can allow you to keep the second loan only if you can get a subordination agreement from the second mortgage lender. The agreement ensures that the second loan has less priority with respect to the new refinance loan. Thus, you need to consult the lender offering refinance loan as to whether he will allow you to keep the second mortgage. You can also compare the rates on the refinance and the second loan to find out if it makes sense to keep the second mortgage and refinance the first or else refinance both into a single loan.
7. Being unaware of Second Mortgage Tax Deduction
There may be cases when your home equity loan/heloc isn't fully tax-deductible. It is better that you don't depend on the lender for such information; rather you should check this out with a tax advisor or CPA.
8. Use Heloc to pay off credit card debts
If you have taken out a Heloc to pay off credit card debts, check that you don't exhaust the available credit limit totally. You may later on find it hard to make the payments in time thereby being unable to manage it.
9. Being unaware of prepayment penalty
There may be a prepayment penalty clause associated with your second mortgage and it can cost you a lot of dollars. So, watch out for the penalty if you are planning to sell or refinance within a short time.
10. Not knowing about life cap
Usually home equity lines of credit have life caps due to which the interest rate can go up much higher than expected and then you will have to make the payments accordingly. So, plan your budget and keep cash reserve so that you can use them just in time.Be it debt consolidation or getting cash for repairs or paying off credit card debts, a second mortgage can be the best choice for your purpose. But you need to know the tips and traps so that you can utilize it in the best possible way.