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Common Mistakes When Looking for a Second Mortgage

Common Mistakes When Looking for a Second Mortgage

Getting a second mortgage or a home equity loan involves similar costs as in case of the first mortgage. So you should look out for a loan program offering suitable rates and terms so that you can pay for both the mortgages simultaneously. But while going for a home equity loan, just watch out for some common mistakes that may lead to complex situations in your loan transaction.

Being alert of such mistakes will help you to secure a cost effective loan program that can serve your purpose as well as help you to repay the existing mortgage according to a predefined plan.

  • No knowledge of pre-payment penalty clause

    There is often a pre-payment penalty clause involved in no-cost home equity loans. It is better to avoid such programs in case you plan to sell your home or refinance the first mortgage within three to five years of taking the home equity loan.

  • Getting a large amount of credit line

    Borrowers often get a large credit line and fail to qualify for other loans. This is because lenders calculate your payments based on the credit available and not the amount used. Even when you have zero balance on your equity line, getting a large equity line indicates huge payments, which makes it difficult to qualify for such loans.

  • Not knowing how home equity loan and home equity line of credit differ

    Borrowers are often not aware of the difference between home equity loan and home equity line of credit. A home equity loan allows you to get a certain amount in a single payment. But with a home equity line of credit, you can avail cash advances for the amounts you require. It is best to use a home equity loan when a borrower requires cash up front for home improvements, debt consolidation, etc. But if you require funds for periodic needs such as children's tuition fee etc, it is better to apply for equity line of credit. Therefore, a basic knowledge of both loans can help you choose the one you prefer.

  • Not knowing the life cap of the home equity loan

    Many people seeking home equity loans are unaware of lifecap which extends to 18%. So you need to plan out as to how you should pay off the loan at a higher interest rate.

  • Not shopping around for the best loan

    Consumers seldom shop around for the loan programs that can offer some benefits as well as allow them to save from lower rates. They borrow such loans from the banks with which they have their checking account. The bank may offer suitable loan programs but it is better check out with different lenders.

  • Not getting the Good Faith Estimate

    A Good Faith Estimate of the closing costs related to the mortgage can help you know about every fees associated with it. This will prevent you from paying higher fees and hidden costs, if any. So it is better that you obtain Good Faith Estimate within 3 business days of receiving the loan application.

  • Thinking that home equity loan is fully tax-deductible

    There may be cases when your home equity loan is not fully tax-deductible. It is better that you don't depend on the lender for such information; rather you should check this out with an accountant or CPA.

  • Assuming a home equity loan is cheaper than car loan or credit card

    Even after the deduction of interest for tax purposes, a credit card can cost less than a credit line. The effective rate on a home equity line is given by,

    Effective rate = rate * (1 – tax bracket)

    If your tax bracket is 30% and the actual rate on home equity line is 15%, then the

    Effective rate = 0.15 * (1 - 0.3)
    Effective rate = 0.15 * 0.7
    Effective rate = 0.105 = 10.5%

    In case your credit card rate is greater than 10.5%, then the home equity loan will be cheaper.

  • Taking a home equity line of credit even when you plan for refinancing in future

    Borrowers often go for home equity line of credit even when they plan to refinance their first mortgage within a few years. But before you do so, just try to find out whether you will be allowed to refinance even when you have taken a second mortgage.

  • Pay off credit card balances from home equity line of credit when your expenses are out of control

    When you take a home equity line of credit to pay off credit card debts, do not keep on withdrawing from the card limit. This will lead you into trouble and you won't be able to manage it. In case you fail to manage the credit card, it is better to stop using it.

A home equity loan can help you acquire cash for making home repairs and consolidating credit card debts and other personal loans. So before you approach towards getting a home equity loan, make yourself aware of these common mistakes. Knowing these, you will be able to choose a loan program that suits your requirements as well as prevent yourself from extra payments in the transaction.

Related Content

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An overview of second loans, home equity loans, or "piggyback" mortgages.

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A home equity line of credit, HELOC, equity line, or equity account, is a type of loan that allows a home owner to tap into the equity of their home to obtain cash for other uses.
Common Mistakes When Refinancing Your Mortgage
Common Refinancing Mistakes

Be aware of the pros and cons of the refinancing process and its various aspects to help avoid problems.

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