We always hear stories from the US of people who took a second mortgage on their houses to raise capital for a second house or to finance an investment opportunity.
A second mortgage is basically a loan that uses your home as collateral. It is called ‘second’ because it is second in line to be repaid if your home is foreclosed.
That means that if you are unable to repay your mortgage, and the lender sells your home, your first mortgage would be repaid first in full, with your second receiving any remaining funds.
Unlike first mortgages that are specific to buying a house, a second mortgage or home equity loan can typically be used for whatever you want. It is not uncommon for businesspeople to take them when they need to expand their businesses.
A second mortgage (home equity loan) can extended to you in two ways:
Lump sum: This is when you get all the money in one installment for use in whatever way you want. You make regular repayments with interest as with other types of loans.
Line of credit: Instead of receiving all the money at once, it can be extended to you as a line of credit. The lender will set a maximum borrowing limit for a given period. You are however not obligated to take the money, and it is just there in case you need it.
Is a second mortgage the same as home refinancing?
These concepts can be quite confusing.
Is taking a second mortgage or a home equity loan the same as refinancing? The answer is no. Both provide the home owner with a way to get cash based on the equity of the house, but they are different in the way they accomplish that.
When you get a second mortgage or a home equity loan, you are getting cash in exchange for the equity in your property. This is a second loan.
On the other hand, refinancing is not a separate loan. It simply pays off your old mortgage in exchange for a new mortgage. You will continue having a single loan to pay, unlike in a home equty loan where you now have 2 or more loans to pay.
Which banks in South Africa offer home equity loans?
All major banks in the country offer this type of loan.
They come with different plans and different names, and he best way to find out the right option for you is to contact your bank.
How is a home equity loan different from other loans?
Afterall, you are borrowing against an asset that you own.
Well, the interest rate on your home loan may be lower, and is typically fixed over the repayment durations. Some other loans see this rate adjusted annually.
A home equity loan is also much easier to get, since the lender has a stable underlying asset protecting their money.
Why take a home equity loan?
The most common reason and indeed the one most publicized by lenders is home renovation and improvement.
Our houses are our temples, and they need to be in a shape we are comfortable with. No one will feel safe with a roof that is almost caving in. Or a wall that has massive cracks.
You may require urgent infusion of capital just to bring back your house to a safe living standard. That would be a good time to take advantage of its equity and take a second mortgage.
The house can also be in need of a facelift. This kind of loan is great for improvements such as in the kitchen or bathroom, or even adding features like a swimming pool. If you are to continue living there, it will add to your quality of life.
If you intend to sell the house or put it up for rent, these improvements will add to its marketability and increase the amount of money you can ask for.
Should you take a home equity loan for investment purposes?
It is tempting to pick up easy money when you think you have a smart investment idea.
However, remember most businesses or investments fail or do not perform well. Do you want to risk homelessness in case this becomes the fate of your own investment?
Putting up other assets, other than your house as collateral is always advised. At least when the hammer falls, you will still have a roof above your head.
Also, with interest rates of about 10% on home equity loans in South Africa, the return on your investment will need to be above that just to break even.
Should you take a home equity loan for an emergency?
It may be tempting to reach into the cookie jar when things go sideways in your life. Owning your own home gives you easy access to lots of capital, often on short notice.
But as much as possible, let this type of loan be your last resort. It is the one loan than can leave you homeless.