What is a 2nd mortgage/ home equity loan?
A 2nd mortgage is a loan that is originated and subordinated behind a first mortgage. 2nd mortgages are also referred to as home equity loans, junior liens, or combination loans. These loans can take on various forms. The two most popular 2nd mortgages are the Home Equity Line of Credit (HELOC) and the Fixed Rate Home Equity Loan.
A HELOC is a line of credit much like a credit card that is secured against the equity in a home. These are most often originated after a person has owned a home but can also be originated as a part of a purchase transaction.
HELOC’s have extremely flexible terms and is an excellent financial tool for homeowner’s with a large equity position in their home. HELOC’s typically have a 10-year “draw” term. During this period a user may borrower up to the maximum amount of the line of credit and pay it back as many times as they wish. Due to the flexible nature of the draws HELOC’s have variable interest rates that are based on the prime index plus a fixed margin. Margins on HELOC’s can vary from -0%-3.00%. The margin is determined by the borrower’s credit and equity available in the home. During the draw period borrowers make a minimum of interest-only payments based on the average balance during a given billing period (much like a credit card). The borrower may make additional payments at any time which will go towards reducing the balance owed against the line of credit. In the event that a borrower does not use the HELOC they will not pay any interest. Some HELOC’s do have an annual service fee charged for the maintenance of the account.
Fixed Rate Home Equity Loan
The most common fixed rate home equity loan is a 30/15 balloon program. With this loan a borrower will take out a sum of money and make payments based on a 30-year amortization at a fixed rate. However, at the end of 15 years if the borrower still had this loan they would be forced to pay-off or refinance the remaining balance. Typically these loans do not carry any penalty to prepay them early.
When would a 2nd mortgage make sense?
We originate 2nd mortgages in many different cases. 2nd mortgages are used as combination loans in purchase transactions in order to allow the client to avoid paying for costly private mortgage insurance. 2nd mortgages are also used when a client needs to borrow a small sum of money for a short period of time to satisfy an unbudgeted obligation. Since 2nd mortgages are relatively inexpensive to originate often times they can be more cost effective than refinancing a larger primary mortgage.