Junior Mortgage
Junior mortgages are secondary mortgages that branch off of existing mortgages.
To understand Junior Mortgages, it is important to understand regular mortgages. Mortgages are some of the most popular and useful loans in the world. Acquiring a house is the cornerstone of a person’s financial life.
A mortgage helps to finance those purchases through loan money. By allowing a person to own a home without paying for the full cost of a house, allows more people to purchase money and participate in the economy.
Junior mortgages are secondary mortgages that branch off of existing mortgages. The existing mortgage or “primary mortgage” is used to branch off another mortgage or a “Junior Mortgage”.
These mortgages are used to pay off other pieces of real estate besides the ones bought with the primary mortgages.
Similar to regular mortgages, junior mortgages are backed by the house bought with the mortgage. They consist of monthly payments and interest to pay back the loan.
Some examples of regular mortgages include:
- Conventional Loans (regular Mortgages from private institutions)
- Conformal Loans (loans that conform to the standards of Fannie Mae & Fannie Mac)
- Adjustable-Rate Loans (mortgage with a fixed interest for up to 3-10 years)
Homeowners often take out these loans to tap into their house's equity or to avoid private mortgage insurance when purchasing a home. Although these mortgages can be a great addition to your housing, it is important to consider all estate and financial obligations.
An additional mortgage is a heavy burden for homeowners. Increased monthly payments require a hard line of budgeting for the average homeowner to accomplish.
And although in the case, a default does occur, you will be allowed to pay off the primary mortgage first. The second mortgage will just extend the time and amount you will be paying off your debt (which is your first mortgage).
Key Takeaways
- Junior Mortgages are secondary mortgages that allow you to use up built equity in your houses.
- Secondary Mortgages are mainly used to refinance, pay off down payments & closing fees, education, or a vacation.
- Secondary Mortgages have higher interest rates and allow borrowers to take out less than a primary Mortgage.
- Home Equity Loans and HELOCs are the most popular forms of secondary mortgages.
Types of Junior Mortgages
There are two main types of junior mortgages, Home Equity Loans and Home Equity Lines of Credit. Under both these mortgages, a property is used as collateral.
The homeowner can opt to tap into his/her home’s equity that has accumulated over the years. Naturally, real estate is generally always appreciated.
Equity is the amount a homeowner has invested into their home. Or the difference in the value of the house compared to the value of the mortgage. For example, if you own a house worth $300,000 and your mortgage is $250,000, you have $50,000 in-built equity.
The types are:
1. Home Equity Loan
Home equity loans operate similarly to loans on a primary residence. These loans allow homeowners to access the equity that their primary house has built up throughout the years.
Instead of having the money you’ve paid off to the house sit there, you can take out this loan and use it to fund other needs. For instance, you could turn that loan into a renovation to increase the value of your house or to purchase a car.
The allowed amount of money will be based partially on the appraised value of the house (around 80-90%) and the homeowner's credit score and financial history.
Unfortunately, since taking out a second loan is a larger risk than one loan for a bank, the interest rate will be higher, and possibly the monthly payments will be higher compared to the original mortgage.
NOTE
Traditional home equity loans have set repayment schedules; monthly payments with interest. Like any other mortgage, if the borrower defaults on the loan, the lender can sell his house to cover the shortfall.
These mortgages are a good option for built-up equity, but once a loan is taken out, it bears a burden on the house. The loan, if not paid, can drop the value at which you can sell the house.
Not surprisingly, these loans are not hard to get. Being secured by the house and a previous history of paying the primary mortgage, most banks would give out Home Equity Loans to most homeowners with a relatively good financial history.
Home Equity Lines of Credit act as a credit card. The lender gives the borrower a set limit on how much money they can take out. The borrower has an obligation to repay the amount lent to him with interest.
Similar to a regular equity loan, the limit of borrowed money is based on part of the equity stored in the house and the borrower's credit history. Generally this results in a borrowing limit of 85% of the value of the house.
Once you take out a certain amount of money, it is considered the draw period. After drawing out money from the line of credit, you will enter the repayment period. Once commenced, you cannot take out any more money and are required to pay back the borrower's money like a regular loan.
NOTE
Home Equity Lines of Credit (HELOCs) have adjustable rates, unlike some mortgages. Multiple factors can cause interest rates to fluctuate. Fortunately, the interest doesn't act as a credit card.
Since the mortgage is secured against the value of your house, the interest rate will be similar to the interest of a mortgage rather than a credit card.
Taking into account the borrower's credit profile, the interest will be increased. The higher your credit score, the lower the interest, and vice versa.
The increase in interest is also known as the “margin”. It is important to be knowledgeable of the markup before signing the loan.
Regardless of the choices, it is best to ask and talk to multiple lenders to secure the best interest rate. Some years have seen interest rates as low as 3% and as high as 8%,
Uses of a Junior Mortgage
Junior mortgages are loans that are taken out against the equity of your home. How one uses these loans is completely up to them. They act just like any other loan, and can be spent on acquiring more real estate, car perhaps, a vacation, tuition, fees/expenses, and the list goes on.
Junior loans can go up to 20% of the valuation of your house/equity asset. Large projects are generally impossible to fund with these loans, but little projects or small funding is the pin mark of such loans. Projects like:
1. Renovation
The most common use of junior mortgages is to renovate the house/property itself. Renovation is one the easiest and quickest ways a homeowner can increase the value of their house.
Although a renovation does not always guarantee that a house will increase in value, it is a solid investment for not only the value of the house but the quality of life for the homeowner.
Most renovations, especially large-scale renovations can expect to bring in a 70-80% return on investment (ROI). Meaning that the cost of the renovation will be added to the value of the house.
Although some projects will have a much smaller ROI, each renovation will add some value to your property.
NOTE
Sites like OpenDoor or any other renovation company can give accurate quotes and estimates on the ROI of a renovation.
2. Down Payments
These loans allow a mortgage's equity to be used to pay for other down payments or closing costs for a separate house/property.
Closing costs may come as a shock to homeowners. Closing costs are the fee you pay to apply for a mortgage. This includes appraisal fees to gauge the value of your house, attorney fees, and escrow fees.
These fees often aren’t discussed or planned for. A loan taken out of a primary residence can help to cover the costs of these payments.
Closing costs can be around 3-8% of the value of the mortgage. This can add up as the mortgage increases. A closing cost plus a downpayment of 20% can hinder a person’s ability to purchase another residence.
NOTE
Junior mortgages can allow you to begin to acquire a secondary or third piece of real estate while paying off the primary mortgage.
Multiple pieces of real estate can be a risk, but most real estate agents or homeowners will use this tactic to acquire more housing to rent out.
If planned correctly, the new mortgages these homeowners acquire will pay for themselves; essentially the homeowner will rent out the house to another family or tenant who will pay the mortgage plus rent on top.
3. Education
The most common scenario is having to pay a child’s tuition fees, especially for private schools or universities.
NOTE
Usually, federal education loans are taken out, also known as “student loans”.
There is, however, the option to pay for a student’s tuition with a junior mortgage because again, junior mortgages can be utilized at the borrower’s discretion.
Some people use this tactic to pay for education due to the loan's nature. As the loan takes a backseat to the primary mortgage, people can first pay the mortgage and wait until they have a more stable income to pay the junior mortgage.
4. Vacation
Surprisingly small loans such as these loans are often used to take a vacation. Unfortunately, without an extremely strong income, luxuries like these are often quite challenging if one has a lot of cash flow constraints and liabilities.
NOTE
The most common people who use these loans in such a fashion often have multiple houses and a large stream of income.
Should You Take Out A Junior Mortgage?
Depending on the usage, it could be an excellent choice to take out a junior mortgage. The most common use of these secondary mortgages is for renovation. Not only will renovation make your house look better, but it will further increase the value of the house.
While a renovation is an exciting proposal for most homeowners, you should consider the possible burden that a second mortgage will bring: higher monthly payments with higher interest.
You should also consider whether you have the financial resources to take on such an added burden. A homeowner may fail to pay off the monthly payments. If this were to happen, the owner could potentially default on their mortgage and run the risk of losing their home.
Luckily, there is an alternative before defaulting which is known as a Mortgage Forbearance Agreement, which allows the borrower and lender to recalculate the payment for a longer term with short-term relief.
Furthermore, there are multiple fees associated with junior loans. Most HELOCs will require an application fee, a title search, an appraisal of your house, and real estate attorney fees. These costs can set you back hundreds of dollars, if not thousands on larger properties.
It is important to think over these possible hurdles before acquiring a secondary or junior mortgage. There are a multitude of other loans that can give you a better interest rate, longer or shorter terms, and a large pool of capital.
Junior Mortgage FAQ
Even though secondary mortgages are useful to obtain a median-sized loan, it depends on your financial security, the amount of equity you have built, and your ability to pay off another loan.
If you have a strong income, a large amount of built-up equity, and extra cash, a second mortgage can be a good option.
While both types of loans are forms of secondary mortgages, each has its unique system. While a Home Equity Loan acts like a normal loan based on the equity of your house, HELOCs are more similar to credit cards.
The best option depends on your financial needs, an Equity Loan is best for a one-time large financial injection, while a HELOC is better for smaller purchases over an extended time.
Both are paid relatively on the same terms. Both have monthly payments with interest and have set terms.
Secondary Mortgages are instantly riskier than the first mortgage. Taking out a secondary mortgage adds more burden onto the borrower. Not only will they have to pay off the first/primary mortgage, but they have to pay off the second mortgage.
This creates an increase in debt and a larger amount of required payments. Because the borrower has more debt, this creates a higher chance that they will default on their loans. This makes banks charge higher interest to balance out the heightened risk,
Personal loans, or most ‘regular’ loans, are quite common and sufficient to cater to an individual’s plan.
Secondary mortgages usually are used to buy assets or services related to the building. For any other use, it is recommended you look into loans that are specialized for your specific need.
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