business start-up

You’ve been thinking about building an office addition to accommodate your home business, or perhaps you have a child entering college. Maybe you just have a heavy debt load among several creditors, and debt consolidation looks like a sensible way to lighten your load. Whatever the reason, you need a sizeable hunk of money. A second mortgage on your home, you’ve heard, offers a relatively easy way to come up with all that cash.

Yes, second mortgages offer several advantages for home business owners seeking a substantial loan, but beware. There are important things to do before you take that big step.

Do Your Homework

Understand the differences between the two basic types of home equity credit: a home equity loan (second mortgage), and a home equity line. A home equity loan is an additional (second) mortgage loan, while an equity line works much as a credit card does.

A second mortgage loan provides money in one lump sum; a home equity line provides credit as you need it. That way, you pay interest only on the outstanding balance. An equity loan is best when you need all the money up front. An equity line may be best if you have an ongoing need for money such as college tuition payments.

Home equity loans usually have fixed interest rates and fixed payments, while most home equity lines are of the adjustable-rate type; if the interest rate goes up, so will your monthly payment. So, if you like things steady and predictable, a second mortgage may be your best choice.     

Remember the Risks

Like all credit options, second mortgages have their downside. Any type of home equity credit requires you to use your home as collateral. If you’re late or cannot make your payments, you risk losing your home. In addition, some second mortgage loans require a large final (balloon) payment that may require you to borrow more money to close out the loan. 

Keep Interest Rates in Mind

Despite the risks, second mortgages remain one of the most popular forms of emergency financing for both business and personal purposes. Once you decide that a second mortgage is the way to go, you’ll need to take a careful look at the interest rate and its terms.

With a fixed-rate loan, the interest rate will usually be set for the life of the loan. However, many lenders offer adjustable rate mortgages or ARMs. These provide for periodic interest-rate adjustments to accommodate changes in the overall economy.

Can You Swing the Payments?

Equally important is a clear understanding of exactly how much your monthly payments will be, and what they cover. Be sure to get this information before you sign.

With traditional loans, you will be required to make monthly payments on the principal and interest. With another type of loan, you may be required to pay interest only on the borrowed amount. With these loans (popularly known as “balloon” loans), your monthly payments will not reduce the principal amount of the loan. Instead, you will be required to pay back the entire borrowed amount at the end of the loan period. If a balloon payment is part of the terms of your loan, be careful. You will have to repay the entire amount when it becomes due. 

How Long Will You be Paying?

Some second mortgage loans may extend for 15 or 20 years, while others may require repayment in as little as one or two years. Review all forms of repayment terms with the lender and select one that best suits your needs.

Let’s say that you need to borrow $25,000 to add a home office. In that case, you may not want to obligate yourself with a loan requiring you to repay the entire amount in one or two years, because the monthly payments may be too high for you to handle comfortably.

There is, of course, a degree of risk in every form of credit. While second mortgages have their own unique risk factors, they remain a popular way for homeowners to finance relatively large business or personal projects at lower costs than other forms of credit. HBM

William J. Lynott is a freelance writer who covers a variety of financial issues.

Previously published in the August 2007 issue of HOME BUSINESS® Magazine, an international publication for the growing and dynamic home-based market. Available on newsstands, in bookstores and chain stores, and via subscriptions ($15.00 for 1 year, six issues). Visit www.homebusinessmag.com