Mistakes are inevitable. According to George Bernard Shaw, "Success doesn't consist in never making mistakes, but in never making the same one a second time." But an educated consumer can succeed without making any.
Here are six common second mortgage pitfalls. If you know them in advance, you can avoid falling into their trap the first time around.
1. Choosing the wrong type. Second mortgages come in two varieties - the fixed-rate home equity loan, and the adjustable-rate home equity line of credit (HELOC). If you know the exact amount you need to borrow, a home equity loan is a good choice. However, if you're looking to finance a project and not exactly sure how much it will cost, consider the flexible HELOC. You can apply for a credit line slightly higher than your needs. If there are any cost overruns, you'll be covered.
2. Drawing too much. Don't forget that you're tapping your available home equity. If you withdraw too much money, it will affect your ability to get more credit, or refinance your mortgage down the road. Always stay conscious and in control of your credit limits so that they don't control you.
3. Forgetting about the life cap. The interest rate of a HELOC is tied to an index, so it can fluctuate daily. However, it also has a "life cap," which is the maximum amount that the interest rate can increase during the loan's lifetime. If you can safely make the payment on your loan at the "life cap" interest rate, you can rest assured that you're not taking on more debt than you can handle.
4. Not reading the Good Faith Estimate. When you apply for your second mortgage, the lender must provide a "Good Faith Estimate" within three days. Read it carefully...it gives a detailed list of all the closing fees involved, so there will be no surprises.
5. Using second mortgage to consolidate debt. It may sound like a good idea - taking out one large low-interest loan to pay off all your high-interest debt - but it's only good in theory. The consequences can be severe if you don't handle the reasons that got you into debt in the first place. If you don't change your spending habits along with your loan type, you can find yourself in even greater debt down the road.
6. Limiting research. As with any mortgage product, it's important to shop around for the best deal. Speak to local lenders, and do research on the Internet. Check with your personal banker and the brokerage house that holds your investment accounts. They may all offer second mortgage options that are competitive, especially if you're an established customer. Refrain from jumping at the first great offer, since it may not be the best.
It's inevitable that you'll make mistakes. But if you learn about possible pitfalls before you make your choice, you can reserve them for areas in your life that aren't involved with mortgages.