So, you’ve made all your mortgage payments on time and built substantial home equity. A second mortgage allows you to borrow against your home equity and use it for crucial expenses. This could be a much-needed home repair, your child’s college tuition, or a large medical expense.
But here’s the thing: Not all homeowners can get the same second mortgage rate. Lenders consider various factors before offering you a rate. Knowing how does a second mortgage work and what factors influence rates can help you prepare. Let’s take a closer look.
Type of Second Mortgage
There are two common types of second mortgages offered by lenders like AmeriSave: Home Equity Loans and Home Equity Line of Credit (HELOCs).
Home Equity Loans
A home equity loan is a lump sum with a fixed interest rate and predetermined monthly payments. These are highly beneficial when you need to pay for a one-time expense, like a home renovation project or debt consolidation.
Home equity loans typically offer high interest rates, especially compared to unsecured loans like credit cards and other personal loans. Nonetheless, they are preferred because of their predictability.
Home Equity Line of Credit
On the other hand, a home equity line of credit (HELOC) works like a credit card. It allows you to borrow money up to your credit limit during a draw period. A HELOC comes with a variable interest rate, depending on market conditions and lender policies. HELOCs are riskier, but they offer flexibility when it comes to repayment.
Credit Score
Your credit score has an immense impact on your second mortgage rate. It is a numerical representation of your creditworthiness and ranges from 300 to 850. The higher your credit score, the lower your interest rate.
Lenders run credit checks to determine how much they can afford to lend you. If your credit score is above 620, you can get a favorable interest rate. Whereas, a lower credit score can lead to extremely high interest rates and even the denial of the loan.
The good news? You can improve your credit score with some simple measures. This includes balancing accounts, limiting credit checks, and paying off credit card bills.
Home Equity
Home equity is the portion of your home that you truly own, and it plays a big role when it comes to acquiring a second mortgage.
Since a second mortgage uses your home as collateral, high equity gives lenders a good chance at recovering their money if you default.
Make sure you have at least 15-20% equity in your home to qualify for a favorable second mortgage rate.
Debt-to-Income (DTI) Ratio
Debt-to-income (DTI) ratio is the measure of how much of your monthly income goes toward debt payments.
The relationship between DTI and the second mortgage rate is pretty simple. A lower debt-to-income rate can get you lower interest rates and better overall loan terms. Whereas, a high DTI (think 45-50%) will make you a high-risk borrower, and lenders might deny your second mortgage application.