Why get a second mortgage?
This question has been posed to us and the internet numerous times. So, let’s clear up why people get a second mortgage – and is it a good idea?
What is a second charge mortgage?
A second charge mortgage is a new loan against your home equity, also known as a home equity loan or home equity line of credit (HELOC). It is one method of borrowing significant sums of money not available through other loans. To understand a second charge mortgage well, you must have a full understanding of home equity.
The equity in your property is calculated by subtracting the existing debt attached to the property (usually just the remaining mortgage balance used to help buy the home) away from the value for your home. It gives a financial sum or percentage of the property that you own outright. For example, a £300,000 property with a £150,000 remaining mortgage means you have £150,000 home equity (50%).
A second charge mortgage allows you to borrow against some of this home equity to receive a larger lump sum than you would with a personal secured loan, unsecured loan or credit card. You would then have two debts attached to the property and need to make separate monthly repayments.
If you were unable to repay either or both of these debts, the respective lender or lenders would be allowed to repossess the property and sell it to recover the outstanding balances of the debts. As long as the value of your home hasn’t decreased, the sale of the property should clear both debts and avoid any significant shortfall that could lead to bankruptcy.
Second mortgages vs second charge mortgages
It’s important to differentiate between a second mortgage and a second charge mortgage.
A second mortgage is when you take out a second mortgage to buy a second property. For example, you have purchased one home with a mortgage but are then going to purchase another property, possibly as a rental investment and need a second mortgage to help fund the purchase.
One issue is that second charge mortgages are often called second mortgages as well. It’s extremely common to hear someone talking about a second charge by using the term second mortgage. We even do it ourselves here at MoneyNerd. You can usually tell the difference by the context of the discussion.
Why get a second mortgage?
There are so many reasons why people get a second mortgage. Below we have named some of the most common reasons why you might want to take out a second mortgage against your home equity.
- Home improvements
Second mortgages are most often used to help fund home improvements. From redecoration to larger projects that include knocking down walls and building extensions, these loans can be a great way to fund home renovations of all shapes and sizes.
Using a HELOC that provides credit over a draw period in stages is an effective way to help budget for projects that are split into different stages. And with a HELOC you only pay interest during the draw period and make capital repayments later.
- Debt consolidation
Debt consolidation is another big use of a second mortgage. This is when you use the money from a second mortgage to pay off other debts, such as personal loans, store cards and credit cards. This should only be done if it makes debt repayments cheaper by securing a lower interest rate in the second mortgage, in comparison to the interest rates you are currently paying. But you should also factor in any early repayment charge and closing costs.
You should also consider debt consolidation loans for this purpose.
- Holiday homes
Some homeowners decide to borrow against their home equity to purchase a holiday home, usually outright. By adding more debt to your main residence, you might be able to buy a small holiday flat or villa abroad without the need to use another mortgage to buy it.
Not as popular but still possible, some people decide to use a second mortgage to fund a special vacation, possibly a wedding abroad or round-the-world trip. This isn’t really an option for a one-off trip to Spain because second mortgages typically require a minimum loan of £5,000-£10,000.
- Big-ticket purchases
The interest rate on a second mortgage could be lower than what you can find through car financing, allowing you to buy a vehicle for cheaper by borrowing against your home equity instead. This can also be done for other big-ticket items, such as a boat.
- Medical and education bills
Private medical and education bills can be expensive. Those wanting excellent medical care or to return to university in later life as part of a career change may choose to borrow the money required using a second mortgage.
- Helping family members
Parents and grandparents could decide to borrow cash against their home equity to help a family member with any of the above. This is most common when helping younger family members get a deposit together for their own house purchase. The interest on the second mortgage could be a lot lower than the mortgage rates benign offered to new buyers.
Is a second mortgage a good idea?
Taking out a second mortgage against your home equity can be a smart way to access much larger credit at a competitive interest rate. However, it is risky because it could make debts unaffordable and cause you to lose your home, and you are at heightened risk of negative equity.
You can mitigate these risks by borrowing against less of your home equity with a smaller loan, rather than utilising the lender’s maximum loan to value ratio. Saving before applying can help you do this.
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