Prior to applying for a loan, it is important for you to familiarize yourself with some basic terminologies in business funding. Two of these basic terms include secured and unsecured loans.
Before identifying what the differences are between a second mortgage and an unsecured loan, let us first define what a secured and unsecured loan is.
An unsecured loan is a loan that is based on the borrower’s credit eligibility. It does not require any form of asset for use as collateral. Since it is considered riskier for lenders, a higher credit score along with a reliable source of income is required for you to get a higher chance of being approved. And to reflect this high-risk aspect, the lender will be offering a higher interest rate, a short term on the loan, and a considerably lower amount since there is nothing for them to seize in the event that the borrower will default on their payments.
Unsecured loans are mostly used for:
- Student Loans
- Personal Loans
- Credit Card Loans
A secured loan on the other hand will require collateral to secure a loan. These are assets such as real estate properties, cars, or equipment. The amount of loan you can apply for will depend on the value of the assets you have presented. In the event that the borrower is no longer able to pay the loan, the lender has the right to seize their assets that were used as collateral as a means of paying the remaining amount in the loan. Since there is lesser risk involved for the lender, applying for it is much easier and interest rates are usually lower as compared to unsecured loans.
Some examples of secured loans are:
- Car Loans
- Mortgage Loans
- Home Equity Line of Credit
- Life Insurance Loans
Based on the definitions given, the main difference between a secured loan and an unsecured loan is basically the collateral; its presence in a secured loan and its absence in the unsecured loan.
So, what would be the difference now between a 2nd mortgage loan and an unsecured loan?
As stated above, a mortgage loan is a form of a secured loan, where the home equity is being used as collateral to secure the loan. In a 2nd mortgage loan, however, the same property is being used as collateral but as an additional loan from the primary mortgage. A borrower is entitled to a 2nd mortgage only if his loan from the home equity has not been zeroed out. Should the borrower decide to take on the 2nd mortgage, the total amount of the primary mortgage will be paid off using the lump sum amount and the remaining amount, therefore, shall be used for whatever purpose the borrower wishes. And same as the first mortgage, the second one shall be paid off in a specified period of time with a fixed amount of interest rate.
Some of the things you’ll have to consider with 2nd mortgage loans are:
The processing time of the loan
When applying for a mortgage, your home is subject to an appraisal. It usually takes the bank around 3-4 weeks, maybe even more, to process the application along with the appraisal. If you are in a time constraint and in need of a faster approval then you might want to consider looking into other alternative private lenders. These are mostly private companies that offer mortgages for business loan purposes. They are more flexible and are less rigid when it comes to the requirements needed.
The amount you can borrow based on the equity of your home
It is important to know that there are limits to how much you can borrow. Normally, lenders will allow you to borrow at least 80% of the value of your home. Even so, you will still be subject to a credit review to assess your capacity to pay. This being said, a high-value property won’t guarantee automatic approval.
2nd mortgage loans may be costly
Closing a loan prior to its final settlement date will entail additional costs, such as closing fees, appraisal fees, and other fees stated in your agreement.
Higher risk involved
You have to draw a scenario where possible outside factors may affect the performance of your business. If this happens, your home is in danger of being foreclosed for non-payment of your loan. So unless you are sure of the returns on the investments or expenses you’ll be making for your business, it might be better to seek for other options.
As to which one would be best for you, it would depend on your purpose. If a large sum of money is needed, such as home improvements, new business capitalization, or purchasing of new equipment in your company then the 2nd mortgage loan would be preferable. But make sure to consider the risks attached to it. Because remember that in cases where you are no longer able to pay for the loan, your collateral will be seized by the lending company. As compared to the unsecured loan where your credit score is the only one at risk. It may be considered as a safer option if there are higher risks involved for the use of the loan you are applying for. Whatever the case may be, make sure to explore all other options and identify the risks involved in it.