Dave Ramsey says debt is BAD!! If you follow BowTiedEffer, you know how great ol’ Davey’s advice can be. Today, we are going over second mortgage options and when you should consider each.
Piggyback Mortgage
Home Equity Line of Credit (HELOC)
Home Equity Loan (HELOAN)
*DISCLAIMER: We are in a recession and there will be continued layoffs, probably for at least the next six months. Do NOT consider these right now just to buy a bunch more house than you need/can afford or if there is the slightest chance you might be laid off and you don’t have additional funds saved up. This is to educate you on your full range of options if you already decided you are buying now and to prepare you to pounce if there is any future blood in your local housing market.
Piggyback Mortgage
As the name suggests, this mortgage piggybacks onto your first mortgage when you buy a house. So why would you ever want to do this?
The piggyback is a way to get rid of PMI (discussed in my last post) when you have less than 20% saved up for a down payment. There are multiple ways this can be structured: 80% first mortgage/10% second mortgage/10% down payment, 80/15/5, 75/20/5, 70/20/10, etc. The reason 75% and 70% first mortgages are even suggested is because of loan level price adjustments. That is for another post, but essentially you can get better pricing on the first mortgage based on the loan to value (LTV) and your credit.
Just this week, I convinced a client to go with us over a builder because of our ability to offer a piggyback loan (despite us having a higher rate because her credit score was lower when we pulled it). She was very concerned with the monthly payment, and we were able to lower it by hundreds of dollars with about the same money out of her pocket. Let’s get into it…
She is buying a $730,000 new construction with 5% down, and the builder is offering the following:
6.125% rate
2.2 points ($15,257)
P&I: $4,214
MI: $260
Monthly payment (excluding taxes and insurance): $4,474
Cash to close: ~$65k
We showed her a couple of options involving a piggyback and she decided on the following:
25% down
6.125% rate
2.5 points ($13,688)
P&I: $3,327
MI: $0
20% second mortgage 6.5% interest only: $791
Monthly payment (excluding taxes and insurance): $4,118
Cash to close: ~$67k
For only about $2,000 more out of pocket, we were able to lower her monthly payment by over $350 dollars.
Before the Ramsey apostles scream that the second mortgage is interest-only and the rate can go up and she will never pay it down, we explained that she can start paying it down with even $100 of the monthly savings and still have a lower payment than the builder’s option and recommended putting a good chunk of her upcoming bonus towards paying off the second. She will have no problem fully paying it off well before her MI payments would roll off.
This is not for everyone, but for people who are very payment-conscious, it is something to consider.
In this example, the second mortgage was interest-only, which is what most people think of when they hear about our next second mortgage, HELOCs.
HELOC
When you need to get some cash for a house project you want to complete or to pay off some bills but don’t want to go through the process of a refinance, you probably immediately think of getting a HELOC. With this mortgage, you are borrowing against the equity you have in your house. Because your house is used as collateral, you will most likely get a lower rate than with an unsecured personal loan or a credit card. It is a credit line, kind of like a credit card, where you can draw money and pay it back to increase the amount you have available to you.
While you can only pull out equity up to 80% of your house’s value in a refinance, you can get up to 90% with a HELOC. The process is quicker than a refi, and if you already have a low mortgage rate, you might not want to refinance your full mortgage at a higher rate - having a smaller HELOC can result in a cheaper overall monthly payment.
Typical terms are either a 10-year interest-only draw period with a 20-year fully amortizing repayment period or a 30-year variable rate. You can usually find them for your primary home and second home.
If you do not like the thought of interest-only payments or the rate changing on you, the HELOAN is a lesser-known option for you.
HELOAN
The HELOAN is a fixed rate, fully amortizing second mortgage. Fixed-rate, fully amortizing is exactly how your first mortgage is set up, so you will have a monthly payment that doesn’t change and eventually is paid off at the end of your term. You can typically get a term from 5 years up to 30 years. You get the full loan amount as a lump sum, so it is better to have an immediate use for all the money, otherwise, a HELOC might be better for you to draw money as needed.
This is an interesting product because you can possibly go up to 95% LTV, and there are places where you can even get them on investment properties. However, they are much less common than HELOCs, so the rate you get for them might not be great, but for something like an investment property where you need the money, it is something to consider.
Wrapping Up
Second mortgages can be a handy tool for a variety of scenarios, whether it gets you into your dream house quicker, or gives you access to your home equity. As with everything in the mortgage realm, the higher your credit score, the more flexibility you will have, especially with these products. If you have under a 680 score, you can kiss most of these goodbye, or expect to pay an obscenely high interest rate.
Remember to consider all of your options and take into account your risk tolerance when looking into second mortgages.
Grizzlie out.