What Is a Second Mortgage and How Does It Work?

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Real estate jargon can get pretty confusing, but it’s likely we all know what a mortgage is. But (pop quiz!) what is a second mortgage? In short, it’s a valuable financial tool for homeowners with equity in their homes.  

There are two types of second mortgages: home equity loans and home equity lines of credit (HELOCs). Both options allow you to capitalize on your home equity in different ways. 

If you’re in the market for a second mortgage or deciding whether you need one, we can tell you everything you need to know about second mortgages, including how to get one and when you should take advantage of one.

What Is a Second Mortgage Loan?

A second mortgage is second in line to your primary mortgage – hence the name. You use your home as collateral for the second mortgage to tap into the equity in your home

You can build equity in your home by paying down your mortgage balance, waiting for your home to increase in value or boosting your home’s value with home improvements.

How Does a Second Mortgage Work?

To understand how you can benefit from a second mortgage, you’ll need to know how much equity you have in your home. To figure out your home’s equity, you’ll need to have your home appraised. Subtract the amount you still owe on your primary mortgage from the appraised value  to calculate your home equity. 

If your home’s appraised value is $350,000 and you owe $200,000 on your primary mortgage, you have $150,000 in equity. But that doesn’t mean you can withdraw $150,000 in cash from your home. Most lenders only allow borrowers to get a loan up to 80% – 85% of the equity they have in their home.

In this case, if you still owe $200,000 on a $350,000 home, you’d only be able to borrow up to $120,000, or 80% of the difference. 

It breaks down to $350,000 – $200,000 = $150,000 (in available equity), and 80% of that is $120,000, which you can borrow.

The amount you can withdraw in equity will vary from one lender to the next and will be influenced by different factors, like your credit score and income.

What Are the Interest Rates for Second Mortgages?

Second mortgage interest rates are typically a little higher than primary mortgage rates. And the rates you’re offered by a lender will depend heavily on your credit score and debt-to-income (DTI) ratio

While you’d likely pay a higher rate for your second mortgage, these rates are almost always lower than the rates you’d get for personal loans or credit cards.

What Are the Requirements of a Second Mortgage?

Getting a second mortgage will look similar to when you got a mortgage to purchase your home. The requirements are largely the same. You’ll need to apply, give them financial documents, and go through the underwriting process

Some homeowners need a better credit score and lower DTI ratio before they can apply for a second mortgage.

When you apply, aim for a credit score of at least 680 and a DTI ratio that’s no more than 43%. A higher credit score and lower DTI can increase your chances of getting a second mortgage. It can also improve the mortgage loan terms.

What Are the Types of Second Mortgages?

There are two common types of second mortgages. 

Home equity loan

A home equity loan pays out a lump sum at a fixed interest rate. The loan is repaid over a given term ranging from 3 – 20 years. 

Home equity loans provide all the cash upfront, which is a solid option if you need money to pay down high-interest debts or have expenses that need to be paid soon. 

The payments on home equity loans start right away. And you’ll be making those payments while also making payments on your primary mortgage. 

Home equity line of credit (HELOC)

A home equity line of credit (HELOC) provides a line of credit you can borrow from on demand during the draw period, which is usually the first 5 – 10 years. At the end of the draw period, you enter the repayment period and pay the remaining balance over the next 10 – 20 years. 

A HELOC offers more freedom and flexibility at a slightly higher variable interest rate. Rather than having to manage a lump-sum payment at the start, the cash is available whenever you need it, and you only pay interest on the amount you withdraw. 

Like some credit cards, you may be charged an annual fee for the HELOC, whether you use your line of credit or not. 

Pros and Cons of a Second Mortgage

Like any loan, second mortgages may not be for everyone. Second mortgages have pros and cons. 

PROS of Taking Out a Second Mortgage👍

Lower interest rates

Second mortgages typically have higher interest rates than primary mortgages. However, second mortgage interest rates are usually far lower than the interest on personal loans, credit cards and other borrowing options.

Higher borrowing potential

Your borrowing limit is directly linked to your available equity. The more equity you have, the more you can borrow.

Tax benefits

The interest on a second mortgage is tax deductible, as long as the funds are used to buy another property or improve or repair your home.

CONS of Taking Out a Second Mortgage👎

Risk of losing your home

Second mortgages are secured loans that use your house as collateral. If you fail to make payments, you could end up losing your home.

Closing costs and expenses

A second mortgage has closing costs. Like a primary mortgage, the costs are generally 2% – 5% of the total loan amount.

Longer application period

A second mortgage can take 4 – 6 weeks from submitting your application to receiving the funds.

Second mortgage vs. cash-out refinancing

Cash-out refinancing is another option for homeowners to access their available equity. Lenders typically cap cash-out refinance loans to 80% of your home’s equity. 

With a cash-out refinance, you get cash in exchange for a new and larger mortgage. You swap out your old loan for a new loan, and any money left over from the refinance ends up in your pocket. 

If your goal is to change lenders and get a better term or interest rate, refinancing may make more sense than getting a second mortgage. Refinancing rates are typically lower than second mortgage interest rates.

Getting a second mortgage can make sense if you don’t want to make any changes to your primary mortgage – which is what refinancing would do. With a second mortgage, your primary mortgage isn’t touched. In other words, you’ll have the same lender, terms and rate. When you refinance, you’re replacing the primary mortgage agreement, not adding to it.

Why Would You Take Out a Second Mortgage?

Taking out a second mortgage can be useful if you plan to use the money to cover repairs and improvements to your home or want to buy or build a second home, vacation home or investment property. 

If you use the loan for any of these reasons, it can help offset the loan’s costs because your interest payments will be tax deductible. 

Second mortgages are also beneficial if you plan to use your home equity to consolidate high-interest debt. But don’t forget the potential downside. You’re using your home as collateral to pay down other debts. 

If you make late payments or miss payments, your loan may go into default, and you could lose your home.

Should you take out a second mortgage?

Taking out a second mortgage to pay for big-ticket things, like a new car, wedding or luxury vacation that don’t appreciate in value, is an option – but it isn’t always advisable. 

In these cases, you’re taking on additional debt to pay for nonessential expenses. Besides not being able to take advantage of any tax benefits, your ability to stay in your home is hanging in the balance. 

You should always ask yourself if what you want is worth what’s at risk. 

Second Mortgage FAQs

Can you refinance a second mortgage?

Yes, you can refinance a second mortgage. Because you pay closing costs when you refinance, you should only consider it if you can save on interest and get more favorable terms.

How long does it take to get a second mortgage?

The approval process for a second mortgage is similar to that of a primary mortgage. Once your application is submitted, you can expect to wait 15 – 45 days.

How long can a second mortgage last?

Depending on the lender, terms and size of the loan, a second mortgage can be repaid in 1 – 20 years.

From 1 Mortgage to 2, Is It Right for You?

A second mortgage is one of the most straightforward ways to access the equity in your home. As long as your home isn’t in jeopardy, a second mortgage can be a savvy way to finance some of life’s biggest expenses. It’s a tool, and like any tool, you’ll need to use it properly to get the job done right.

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The Short Version

  • A second mortgage lets you use your home’s equity to take out an additional mortgage on your home
  • To understand how you can benefit from a second mortgage, you’ll need to know how much equity you have in your home
  • The two types of second mortgages are home equity loans and home equity lines of credit (HELOCs)
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