When you hear the term,’ Second Mortgage’ just think ‘Equity Loan’. This is when homeowners leverage the money they have already paid back or put into the principle of their mortgage, whether it is equity gained or down-payment. In the past, homeowners were able to write off the interest payments on their taxes, however now they can only take a tax deduction if the loan money is used for home additions and renovations. Home Equity Loans usually have a pay off term of 5 to 15 years. The two types of loans are a ‘Fixed Rate Loan’ and a ‘Home Equity Line of Credit’ (HELOC).
The difference between these two loans are with a Fixed Rate Loan, the Homeowner receives one large lump sum payment upfront with a set interest rate and payment amount for the life of the loan. With a Home Equity Line of Credit, the Homeowner is approved for a certain amount of money, which they can go to and use whenever they have a need for it. Sort of like a credit card, this loan has a ‘variable interest rate’, which means that monthly payments and interest are calculated on the amount of money borrowed, by the current interest rate of the loan. With this loan your payments can fluctuate with the change of the interest rate.
There are Pros and Cons of both of these types of loans. If you need the full amount right away, then go with the Fixed Rate Loan. If you want to use the money as an ‘As needed’ fund, then a HELOC would be better. Why pay interest on money that you don’t need yet? Just remember that you are borrowing from the equity in your home, which means you are attaching a lien to it that will have to be paid back at a certain amount of time. For example, let’s say you have a property worth $1,000,000 and you have a mortgage owed of $250,000.You would then have about $750,000 in equity in your home. So, you go to the bank and borrow $100,000 with an Equity Loan. The interest rate is usually going to be higher than your mortgage because the lien would be a secondary lien on the property. This means that if you foreclose on the (primary) mortgage, the bank may not get all their money back, as the second lien holder.
There are also closing costs associated with a Home Equity Loan, since the loan will be recorded with the bureau of conveyances.
Equity sharing, also known as shared equity financing, is a popular way for people with a low down payment or no down payment to buy a home. It is also a way for people to make relatively a low risk real estate investment that does not require management and can provide tax benefits. It is frequently used by parents wishing to help their cash-strapped children buy their first home. Today, a rapidly emerging financial industry is providing down payment and home equity funds to the general public using innovative shared equity financing models and crowd-funding. But, that's for another blog.
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