Taking Out A Second Mortgage On Investment Property

Key Takeaways

  • A second mortgage can fund the acquisition of a subsequent investment property if you have enough equity and the lender’s approval on your side.
  • 2nd mortgages can be very advantageous if the proper steps are taken, but be sure to familiarize yourself with the risks before moving forward.
  • Using a second mortgage on investment property can be a great move for those that are confident they’ll be able to make each payment on time.

A second mortgage, not unlike a primary mortgage, can serve as a great source of funding for those that know how to navigate the process. From consolidating debts to rehabbing existing 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 the equity they have managed to build up in their primary residence can actually be leveraged into an investment opportunity.

What Is A Second Mortgage?

As their names would lead you to believe, second mortgages are exactly that: a second mortgage taken out on a property while an original mortgage is still in effect. More specifically, however, the second mortgage is secured with the same asset as the first (usually your primary residence). As a result, most lenders view second mortgages as riskier endeavors, and will increase the stakes as 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, but 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 a number of 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 using a second mortgage on rental property:

  • 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 absolutely certain you can pay off the added monthly debt associated with a second mortgage. This includes any rent, mortgage payments, utilities, property taxes, homeowner’s insurance, and any 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 the one that 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 actually borrow. Home equity loans, on the other hand, are good for borrowers that need a large sum of money upfront, perhaps tp 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 now 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. If you are in good standing with your current lender, your own bank may represent the best option for taking out a second mortgage. Since they are already familiar with your borrowing history, they may be more inclined to let you take out a second mortgage. If their terms and interest rates don’t appeal to you, don’t hesitate to look elsewhere. The worst thing you can do when shopping around for a second mortgage is to ignore every option at your disposal. In exercising your options, you should find rates that agree with what you hope to do.

  • 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.

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. In the event 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 for 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 be able to leverage a second mortgage into an opportunity to make money, it may be worthwhile.

Is Interest On A 2nd 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 each and 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 you assume you can make deductions on your own home.

Investors have proven, time and time again, that a second mortgage 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.

Have you ever entertained the idea of taking out a second mortgage to cover the down payment of a rental property? Let us know what your thoughts on this strategy are in the comments below.

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