A second mortgage, not unlike a primary mortgage, can serve as an excellent funding source for those who know how to navigate the process. From consolidating debts to buying additional investment properties, second mortgages can cover a wide variety of expenses that would otherwise be too expensive for most homeowners. What many don’t realize, however, is that a second mortgage doesn’t need to originate from a primary residence. It is entirely possible to take out a second mortgage on investment property assets. While the process and qualifications are slightly different, using a second mortgage on rental property assets can be a great alternative funding source.
What Is A Second Mortgage?
A second mortgage is exactly what it sounds like: a second mortgage is taken out on a property while an original one is still in effect. More specifically, however, the second mortgage is secured with the same asset as the first. As a result, most lenders view second mortgages as riskier endeavors and increase the stakes they see fit. In addition to stricter underwriting, second mortgages typically carry a higher rate of interest. Some investors will find the added costs well worth the price of admission. Those homeowners lucky enough to have equity in their first home can borrow against it with a second mortgage. The more equity, the more the homeowner will be able to borrow. Still, the second mortgage comes with a significant caveat: the first home will serve as collateral for the second mortgage, which means there’s a lot at stake for anyone looking to take out a second mortgage.
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How To Get A Second Mortgage For A Rental Property
It is entirely possible to get a second mortgage on investment property. In fact, second mortgages can be used for several things, not the least of which include personal expenses. According to MortgageCalculater.org, “there can be various reasons to take out a second mortgage, such as consolidating debts, financing home improvements, or covering a portion of the down payment on the first mortgage to avoid the property mortgage insurance (PMI) requirement.” What’s more, it’s entirely possible to use a second mortgage to buy a subsequent rental property or at least pay part of the down payment. Here’s how to go about taking out a second mortgage on rental property assets:
Do Your Homework: Provided you are confident in your ability to pay back the loan, a second mortgage can serve as a great source of funding for a subsequent deal. That said, second mortgages aren’t without their drawbacks, namely, one’s exposure to risk. If you are interested in taking out a second, be sure to familiarize yourself with everything, good and bad. It is particularly worth noting that a second mortgage comes with more monthly bills, a higher interest rate, and it will use your primary residence as collateral. With that in mind, you’ll want to make certain you can pay off the added monthly debt associated with a second mortgage. This includes rent, mortgage payments, utilities, property taxes, homeowner’s insurance, and additional community fees.
Determine The Type Of Second Mortgage You Want: Borrowers are awarded the options of choosing between a home equity line of credit (HELOC) and a basic home equity loan. Each has both positives and negatives, so be sure to choose what works best for you. A HELOC, for example, operates a lot like a credit card, as borrowers will only need to pay back the amount they borrow. On the other hand, home equity loans are good for borrowers that need a large sum of money upfront, perhaps to buy a rental property.
Check Your Credit Score: Traditional lenders prefer to mitigate as much risk as possible, which suggests they are more willing to lend to those with higher credit scores. Therefore, if you want to take out a second mortgage on your home, be sure your credit score will allow you to do as much. Your credit report will determine several things moving forward, not the least of which will help banks determine whether or not to lend you more money.
Determine How Much Equity You Have: A second mortgage is made possible by borrowing money against the equity in your house, so it’s important to know how much equity you have in the first place. Of course, to do so, you’ll need to have your home appraised for an accurate home value. The amount of equity you have in a property will lend itself to the amount banks will be willing to give you in a second mortgage. The more equity you have in your current home, the more likely you be approved for a larger second mortgage.
Shop Around: Once everything appears to be in place, it’s time to shop around for the right lender. If you are in good standing with your current lender, your own bank may be the best option for taking out a second mortgage. However, if their terms and interest rates don’t appeal to you, look elsewhere. The worst thing you can do when shopping around for a second mortgage is to go with the first option you find. Seek out lenders who have experience working with other investors, as they may provide you with more favorable terms. Ask for rate quotes and gather information on whether or not they own rental properties. By searching for investor-friendly lenders, you can help avoid any surprises during the underwriting process. Again, don’t be afraid to exercise all of your options to find the best loan terms.
Sign The Papers: Once you have found a second mortgage you are happy with and the rates are reasonable, get ready to sign the papers. However, don’t sign them without reading the fine print. Read the lending disclosures as carefully as possible, as some will come complete with hidden penalties.
Plan For Additional Costs
Before you decide to take out a second mortgage, carefully explore the costs associated with buying a second property. The second mortgage is just part of the equation. Even if you’re able to pull it off, you’ll want to make sure that you can also afford all of the costs associated with owning a second house.
Some of these costs include property management, insurance and taxes, furnishings, and maintenance.
For starters, you may want to hire a property manager if you’re unable to manage your second property full-time. This is especially true if you’re using it as a rental property or vacation property. A manager will be responsible for marketing and renting out the property, screening tenants, dealing with turnover, and overseeing maintenance and repairs. They typically charge a percentage of your rental income, so be sure to factor in this cost. However, having peace of mind is often well worth the expense.
Then, you’ll need to estimate the cost of property taxes and insurance premiums. Your taxes and allowable deductions will vary based on how the residence is used. The location of your second property will also determine what kind of insurance policies you might need. For example, a beach house might require flood protection. These added insurance premiums might be more than what you’re used to. It’s best to consult experts and financial advisors so that you can budget for these items properly.
Last but not least, plan ahead for expenses related to furnishing and maintenance. You may need to procure some furniture and appliances for your second house, especially if you plan to use it as a vacation rental or personal residence. Once the property has been set up, you’ll need to pay for the cost of regular upkeep, maintenance, and repairs. These costs can fluctuate, so it’s recommended that you overestimate than underestimate.
Second Mortgage Vs Home Equity Loan
To be clear, a home equity loan (HEL) is a type of second mortgage. In fact, there are two primary types of second mortgages: home equity loans and home equity lines of credit (HELOC). While the two sound similar, there are subtle differences that make each of these options unique. While a HELOC works a lot like a credit extension, allowing borrowers to use as much or as little of their own equity, home equity loans provide a single lump sum of money upfront.
With a home equity loan, the lender will provide borrowers with a loan based on a percentage of equity in a respective asset. Rarely will lenders allow homeowners to borrow against all of the equity in their assets. Therefore, investors with $100,000 in equity in their rental property may be able to borrow a percentage of the money they have in equity, up to whatever the lender deems acceptable for their particular situation. Since home equity loans are, in fact, a one-time lump sum, their interest rates are fixed.
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Second Mortgage On Rental Property: Pros & Cons
Taking out a second mortgage on investment property assets has served investors as a great alternative source of financing. If, for nothing else, the more ways an investor knows how to secure funding, the more likely they are to secure an impending deal. However, it should be noted that a second mortgage on rental property assets isn’t without a few significant caveats. Like nearly every strategy used in the real estate investing landscape, one must weigh the pros and cons of second mortgages. Only once an investor is certain the positives outweigh the negatives should they consider using a second mortgage on investment property assets. Here are some of the most common pros and cons of taking out second mortgages on rental properties to help you form your own opinion.
A second mortgage allows homeowners to tap into otherwise stagnant, non-performing home equity and put their money to work for them.
A second mortgage may be used to fund home improvements.
Second mortgages allow homeowners to buy subsequent investment properties. Otherwise known as a second mortgage investment property, an investment purchased with a second mortgage is capable of returning more profits than unused equity.
A second mortgage may be used to pay off other loans or debts.
Second mortgages are secured by the asset they are taken out against. Therefore, any missed payments or failure to meet mortgage obligations could result in the loss of the original asset (the home used to borrow equity against).
- Investors often need strong credit to secure a low interest rate when applying for a second mortgage
Used improperly and without a plan to generate a profit, second mortgages are simply another way to turn equity into debt.
Second mortgages reduce one’s liquidity, making them more susceptible to a financial crisis.
You can’t always deduct interest from a second mortgage, unless the loan was obtained to improve the property.
Turning Your Second Mortgage Into Profit
Second mortgages can serve as a great source of funding. The equity one has in their own property is a great source to tap into, but I digress. Using the equity in your primary residence isn’t without risk. As I already alluded to, a second mortgage will use the original asset (your own home) as collateral. If the borrower of a second mortgage can’t stay current on their payments, the lender can go after their home. Second mortgages need to be taken very seriously; do not simply take one out for the trivial purchase of material possessions. The repercussions that coincide with late or missed payments are too severe to risk such a trivial purchase. That said, second mortgages can represent a great opportunity for those looking to make a profit. If you are confident you’ll leverage a second mortgage into an opportunity to make money, it may be worthwhile.
Is Interest On A Second Mortgage Tax Deductible?
Tax deductions, to this day, remain one of the single greatest benefits of real estate investing. Done correctly, tax deductions can significantly reduce your taxable obligations every year and ultimately contribute to your bottom line by, well, not deducting from it. The mortgage interest deduction, for example, is a great opportunity to write off the interest you pay on your primary mortgage. What many people don’t realize, however, is that there’s an opportunity to take similar deductions on a second mortgage, too. Of course, there are criteria you must meet if you hope to claim deductions for a second mortgage; namely, you will need to live in the home the second mortgage covers for at least two weeks or more than 10% of the amount of time it’s rented out over a year (whichever is longer). Then, and only then, will you be able to deduct the interest on your second mortgage. Still, be sure to consult a tax professional before assuming you can make deductions on your own home.
Second Homes Vs. Investment Properties
The difference between second homes and investment properties is that a second home is a property that you occupy for a portion of the year. In contrast, an investment property is a property that you do not live in for any portion of the year and instead own for income-generating purposes. You will find that mortgage rates and down payment requirements are higher for investment properties than for second homes. This is because lenders find that homeowners are more likely to stay in possession of second homes than an investment property if they were ever to find themselves in financial trouble. The requirements are similar for both forms of properties, but lenders may require that a borrower has experience managing properties before approving a loan for an investment property.
Alternatives To A Second Mortgage
A second mortgage is not the only way to utilize your equity for additional financing. In fact, there are numerous creative real estate financing methods that can be helpful in these situations. A few options include:
Cash-out refinance: Investors hoping to tap into a property’s equity can apply for a cash-out refinance. This option gives investors access to quick cash, though there are application requirements and interest rates to consider.
Private money lender: If you don’t want to dip into your existing equity, consider reaching out to your network. A private money lender may be able to provide the funds you need to continue building your portfolio. The best part is, you can negotiate the requirements of the loan.
Personal loan: Depending on how much cash you need, you can consider applying for a personal loan through a lender. These loans are not secured by a property, but instead rely on your personal finances.
The above list contains just some alternatives to a second mortgage. Remember to always consider all the pros and cons before pursuing a new form of financing for your next investment.
Investors have proven, time and time again, that taking out a second mortgage on investment property assets can serve as an invaluable source of funding for a subsequent deal. They are not without risk, however. The loan will use a homeowner’s primary residence as collateral. That means any failure to maintain mortgage obligations could result in severe consequences. With that in mind, do not underestimate what second mortgages are capable of: they are a powerful funding tool, but you must know what you are getting into before you borrow on the equity you have already built in a home.
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The information presented is not intended to be used as the sole basis of any investment decisions, nor should it be construed as advice designed to meet the investment needs of any particular investor. Nothing provided shall constitute financial, tax, legal, or accounting advice or individually tailored investment advice. This information is for educational purposes only.