Homeowners DO NOT use secondary mortgages
An intuitive conclusion from the scarcity of homes for sale is that the percentage of owners in their homes has been increasing for several years. Long term ownership, along with a rapid rise in prices, causes homeowners to accumulate tens and hundreds of thousands of dollars in home ownership. But you might want to secure that fortune.
According to historical data from the Federal Reserve, significant home equity has historically resulted in homeowners taking out secondary mortgages. This was particularly true from 1988 to 1992 and again from 2000 to 2005. From 2005 to 2008 there was another slight increase in the number of second mortgages. But since banks showed how easy it is to foreclose and withdraw equity, mortgages have plummeted. Home equity loans have been in steady decline since 2009. The number of American homeowners paying for both a primary and secondary mortgage or home equity loan has fallen by about half since 2009, according to the Census Bureau.
If current homeowners aren’t selling to move to a bigger and better home, should they use existing equity to fund home improvements, extensions, and other financial reasons? There are options as well as advantages and disadvantages to this question.
Should you take out a second mortgage?
There are two basic types of second mortgages. One is a lump sum loan that is backed by the equity you already have in your home. Typically, a second mortgage will last up to 80 percent of the equity you have.
The second type of loan is the home equity line of credit (HELOC). As noted in the title, you can access credit when you need it by writing a check or using a credit card instead of using them as a lump sum.
A major reason for the decline in second mortgages is that the interest deduction severely limits the use of the money. The interest is not tax deductible if the money is used to repay student loans, to consolidate consumer loans, nor is the interest tax deductible if it is used as a down payment for vacation rentals or for any other use that is not directly related to that House through which the loan is secured.
“The Tax Cuts and Jobs Act of 2017, enacted December 22nd, suspends interest on home loans and lines of credit from 2018-2026, unless they are used to buy, build, or buy the taxpayer’s home significantly improve the loan. “ – IRS, IR-2018-32, February 21, 2018
In addition to tax deduction, there are other important considerations. An important factor is the annual percentage (APR). This is the full amount of interest that you will pay on a one year loan. The APR includes any fees you may have to pay plus the interest rate. While personal loans typically have a higher interest rate, the APR on a second mortgage can be higher due to all of the other fees. Taking out a second mortgage is roughly the same as taking out a first mortgage. Tons of fees and costs like appraisals go into the cost of obtaining the loan. You can usually include all fees in the borrowed amount. However, this increases the loan amount, which also increases the monthly interest. Before you assume the slightly lower interest rate on a second mortgage compared to a personal loan will save you money.
And then there is the problem of foreclosure. This second mortgage is secured by the equity in your home. If for any reason you default on payments, the bank can and will foreclose your home. On the other hand, most personal loans are unsecured (the reason for a higher interest rate). If you default on most personal loan payments, it will have a negative impact on your creditworthiness, but most likely nobody will take your home away from you. And here’s a kicker, your home equity is still working in your favor for a personal loan. Your equity is probably your greatest asset. If this value is used to calculate your total and net worth, you will likely get a lower interest rate on a personal loan.
Deciding between a second mortgage or a personal loan is more complicated, but these are the most important considerations for most people.
Homeowners don’t even use home improvement second mortgages
The move away from second mortgages to personal loans is unmistakable. According to a survey by TD Bank, 9 in 10 people (90%) use personal resources to finance home improvement. This is in line with data from the Federal Reserve, which shows a continued decline in the number of home equity loans taken out.
The TD Bank survey found that almost all home owners planning home improvements are finding sources of money other than second mortgages. People planning to upgrade their kitchens, add another bathroom, or just renew the landscaping say the money comes from:
- 98.51% will use personal savings.
- 6.32% take out a personal loan.
- 1.05% will use bonuses and commissions.
- 1.05% borrow from other sources such as family and friends.
- 0.0% is financed with a home equity loan.
You cannot write off the interest on these other sources of credit. On the other hand, however, your home is not at risk of foreclosure. The approval process for a personal loan is also significantly faster and requires less time and energy.
Surely you have thoughts and experiences with second mortgages or personal loans. Please share by leaving a comment.
Additionally, our weekly Ask Brian column welcomes questions from readers of all levels of real estate experience. Please email your questions, inquiries or article ideas to [email protected]
Author Biography: Brian Kline has invested in real estate for more than 35 years and has been writing about real estate investing for 12 years. He also has over 30 years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives in Lake Cushman, Washington. A vacation destination near a national and Pacific ocean.