Whether you’re thinking about going back to school or making a major repair on your home, you’re probably asking yourself one very important question, “Where am I going to get the money to pay for this?”
If you’re like most Americans, you may not have a ton of money stashed away in savings.
A recent report by the Federal Reserve found that 39% of Americans don’t even have $400 on hand to cover an emergency.
If you find that you’re in need of a large sum of money but aren’t sure where to get it, a second mortgage may be the answer. A second mortgage allows you to tap into your home’s equity to take care of your expenses.
What Is a Second Mortgage?
A second mortgage is a loan that you take out against the equity that you’ve already put into your home.
Home equity is the difference between what you owe on a mortgage and how much your home is currently worth.
How To Calculate Home Equity: Appraised Value Minus Mortgage Balance
So, let’s say you owe $150,000 on your home, and your home is worth $250,000. (The amount your home is worth is also known as the appraised value of the home, and it can go up or down.)
This means you have $100,000 worth of equity in your home. When you take out a second mortgage, you can borrow against the $100,000 that you’ve already paid into your home.
Unlike other types of loans, such as student or auto loans, you can use the loan from your second mortgage for almost anything.
How Does Getting a Second Mortgage Work?
The steps to take out a second mortgage are very similar to the steps to take out the first mortgage. While the specific requirements will depend on the lender you work with, generally, you’ll need to submit an application that provides documentation on your income, debts and more.
And of course, you’ll need to have some equity built into your home already because the equity is what you’re borrowing against.
Most lenders only let you take out a portion of your equity, so that there’s still some of it left in your home.
It depends on who you apply to, but some lenders will let you borrow as much as 90% of your home’s equity for your second mortgage.
For example, if you have $100,000 in home equity, some lenders will let you borrow $90,000 when taking out a second mortgage.
Types of Second Mortgages: Know the Difference
If you decide to take out a second mortgage loan, you have two options to choose from: a home equity loan (HEL) or a home equity line of credit (HELOC).
|Home Equity Loan
|Provided in a lump sum
|Take out money as you need (like a credit card)
|Adjustable interest rates
|Fixed interest rates
|Only pay interest on the amount you draw
|Offers interest-only payment options
The Pros and Cons of a Second Mortgage
The decision to take out a second mortgage shouldn’t be made lightly. Before you apply, it’s important to weigh the pros and cons.
Pros of a second mortgage:
- You can borrow more money: Some lenders let you borrow as much as 90% of your home equity with a second mortgage, meaning you’ll probably get more money than you would with another type of loan.
- Low interest rates: Second mortgages usually come with lower interest rates than credit cards or private loans.
- Flexibility: You can use the funds from your second mortgage loan however you wish. You can even use it to buy a second home.
- Tax-deductible interest: If you use the second mortgage to make significant improvements on the home you used to secure the loan, the interest may be tax-deductible.
Cons of a second mortgage:
- High interest rates: You may get a better interest rate if you refinance your first mortgage instead of taking out a second one.
- May not qualify: If you don’t have enough equity in your home, you may not qualify for a second mortgage.
- Potential strain on your finances: Taking out a second mortgage means adding another monthly payment to the mix. So make sure you have the finances to cover these payments.
- Risk losing your home: If you can’t pay your second mortgage back, your lender can take your home.
Money Tips for Getting a Second Mortgage
Here are some tips to make the second mortgage application process go smoothly:
1. Compare all of your options
Before you dive into the application process, make sure that taking out a second mortgage is the right option for you.
After doing some research, many people realize that refinancing their first mortgage is the better (read: cheaper) option.
With a second mortgage, you’re taking out an entirely new loan and adding another mortgage payment onto your financial to-do list.
With refinancing, on the other hand, you’re replacing your primary loan with a new loan. When you refinance, you can change your loan term, switch your lender and adjust your interest rate.
Many people prefer to refinance their first mortgage instead of taking out a second mortgage because:
- Interest rates are lower
- You have only one monthly mortgage payment
- You *may* be able to borrow up to 100% of your home’s equity
- You can adjust your mortgage rate and term, which may come in handy if you’re having trouble making monthly payments
2. Build up some equity
The more equity you have in your home, the bigger the loan you can take out for your second mortgage. Plus, most lenders want you to have a certain amount of equity in your home before they approve you for a loan. Typically, you’ll need at least 15% – 20%.
If your home is worth $200,000, this means you’ll need to have $30,000 to $40,000 in equity to qualify for a second mortgage.
3. Boost your credit score
The higher your credit score is, the lower your interest rate will likely be for your second mortgage. Typically, 620 is the minimum credit score you need to qualify.
You will also need:
- A history of meeting your monthly mortgage payments
- A strong income history
- A debt-to-income ratio lower than 43%
4. Shop around for the best rate
Second mortgage interest rates are not the same across the board.
To get the best rate, start by contacting your local bank or credit union. Make sure to get quotes from several different lenders, including online lenders.
5. Get your paperwork in order
You’ll need certain paperwork to close the loan, including:
- Your last 2 years of tax returns and W-2s (if you’re self-employed, you’ll need 2 years of tax returns)
- A copy of your property deed
- A recent tax appraisal
- Proof of income (this can include income sources such as alimony, child support, inheritance, disability payments, etc.)
- Homeowners insurance information
- Your current mortgage statement
- A list of all of your open credit accounts
- Your last 3 to 6 bank statements
If you get rejected after applying for a second mortgage, don’t be afraid to ask your lender why.
Sometimes, a simple error can disqualify you. Asking will help you secure a second mortgage in the future.
Making a Second Mortgage Your First Choice
So, given everything we’ve covered, is a second mortgage right for you?
If your answer is a firm Y-E-S, feel free to dive back into this sea of tips (repeatedly) to make sure you have everything in order before you apply.
The Short Version
- A second mortgage is a loan that’s taken out against the equity (or money) you’ve already put into your home
- There are two types of second mortgages: home equity loans and home equity lines of credit
- Before taking out a second mortgage, consider the pros and cons, and make sure you have everything in order when applying
Federal Reserve System. “Report on the Economic Well-Being of U.S. Households in 2018 – May 2019.” Retrieved October 2021 from https://www.federalreserve.gov/publications/2019-economic-well-being-of-us-households-in-2018-dealing-with-unexpected-expenses.htm