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By Lisa Rinkus | Citizens Staff
Key takeaways
- You can take out a second mortgage loan after you’ve built equity in your home.
- Second mortgages typically have higher interest rates than primary mortgages.
- Some homeowners choose to refinance when interest rates are low rather than take out a second mortgage loan.
So, you’re driving around a neighborhood where you’ve always wanted to live. There are good schools nearby, a lively town center, public transportation is within walking distance, and there’s a beach close by. This is prime real estate at its finest. The pièce de résistance? You grew up down the block and would love to have your family experience the area of your old homestead. Suddenly, you almost veer off the road when you spot a “For Sale” sign on the front lawn of the house you’ve been eyeing for years. Your palms are sweating, and you’re giddy with excitement, but reality jolts you back to earth. The problem? You’re already paying a substantial mortgage and don’t have the money for a down payment. The solution? A second mortgage may be in the cards.
A second mortgage is commonly referred to as a home equity line of credit (HELOC) or a home equity loan. These options may be a more streamlined approach for obtaining the funds you need for things that suddenly come up — like the dream house you just saw in that primo neighborhood. By taking out a second mortgage, you can get the cash you need without having to sell your existing home under pressure because you need the money from the sale for the down payment. Of course, there are many other reasons to apply for a second mortgage. These include medical bills, tuition, home remodeling, debt consolidation, vehicles, or big events like a wedding.
You can take out a second mortgage after you've built equity in your home, usually through paying down a portion of the outstanding principal on your first — or primary — mortgage. This option allows you to borrow against the equity in your home without having to change your existing mortgage rates and terms with a second mortgage lender.
Technically, the term “second mortgage” refers to the actual lien position on the property. The Consumer Finance Protection Bureau (CFPB) refers to this type of loan as a “junior-lien” because you are using your home as collateral for another mortgage lender. (There is also a home loan option called a “piggyback” second mortgage, according to the CFPB. This occurs when the homeowner takes out a HELOC at the same time as the main mortgage. Consumers take out this type of loan when they need more money for a down payment. These loans have many different brand names but are based on the same type of structure.)
Are rates higher for a second mortgage?
Typically, the answer is yes. Here’s why:
Your first mortgage is referred to as the primary mortgage because it will always take precedence, in terms of getting paid back. Because your original lender has a lien on your property, they can take it as collateral if you can no longer make the monthly payments for your original mortgage. The lender of the second mortgage does not have that guarantee, so the loan is much riskier. Therefore, the borrower must pay a higher interest rate. The good news? The interest rate on a second mortgage is typically lower than other forms of credit, like personal loans (such as a student loan) and credit cards, so taking one out to pay off those loans might make financial sense.
Keep in mind that the standards for getting any one of these second mortgage loans is different for all lenders, so it’s always a good idea to shop around.
A second mortgage vs. a refi
- A home equity line of credit (HELOC) is a type of second mortgage that allows homeowners to take out cash on a revolving basis. This open-ended loan is popular because of its flexibility — it works like a credit card in that you only pay interest on the money you use (or “draw”) from the credit line. The “draw period” for a HELOC is usually 10 years, while the repayment period can be 20 to 30 years. Interest rates for this type of loan are usually variable.
- A home equity loan is also a second mortgage. With this option, you’d get paid a lump sum for the total loan amount. These close-ended loans have fixed rates and are often used for large, up-front expenses, like putting a down payment on a second home.
- A refi (refinance) is not considered a second mortgage. You will want to do a refi if you can get a reduced interest rate and better terms. If you take out extra cash, in addition to a new mortgage, this type of refinancing is known as a cash-out refi. Both options feature a fixed interest rate and are categorized as close-ended loans.
There are many advantages to these second mortgage loans, as summarized below. The biggest plus? Unlike an auto or a student loan, borrowing based on the equity in your home allows you to use the money for anything, from purchasing a new car to a vacation.
Home Loans 101: basic differences and how they’re typically used:
Option | Used to | When it makes sense | When it doesn’t make sense |
Refinance | Take advantage of a lower mortgage interest rate Get better loan terms Pay off the PMI (Private Mortgage Insurance) you’ve been paying on your first mortgage if you didn’t put down 20% | If mortgage interest rates are low and you can save thousands of dollars If you want to lower your mortgage payments If the market value of your home has gone up When you’ve been in the home for a long time and have acquired substantial equity The interest may be tax deductible | If you can’t get a lower interest rate or better terms than your original mortgage If your mortgage balance is almost paid off You plan to move within the next few years If you plan to repay the loan off early and there’s a prepayment penalty |
Home Equity Line of Credit | Pay for expenses that come and go, such as tuition or health care (when maximum flexibility is needed) | If you need cash, but not all at once You would like to pay interest only on what you need The interest may be tax deductible* | When you can’t afford to pay a second mortgage rate that is higher than your original mortgage rate You don’t like the unpredictability of a variable interest rate that could balloon upwards |
Home Equity Loan | Fund significant expenses, such as a down payment on a vacation property, remodeling or debt consolidation | You need a large sum of money all at once You are more comfortable with a fixed Interest rate that won’t fluctuate The interest may be tax deductible | When you can’t afford to pay a higher interest rate If you plan to pay the loan off early and there’s a prepayment penalty |
To apply for any of these loans, pay stubs, a credit report, 1099s or W-2s, and other paperwork will be required by the lender to prove you’re secure and creditworthy. You’ll also need a home appraisal, even if you had one done when you bought the house. This will determine the current loan-to-value ratio by the lender. Regardless of the type of loan you apply for, in order to qualify for the loan in the first place and get the best rates, you should have a high credit score (620 or higher), a low debt-to-income ratio and at least 20% equity in your home. Of course, different lenders may have different standards.
The turnaround time for getting one of these loans — which includes the application process, the underwriting and the closing — usually takes between 2-6 weeks. Be prepared to pay origination fees, appraisal fees and closing costs, just like you did when you purchased your home.
Of course, whenever you take out a loan using your property as collateral, you will lose equity as a result, so taking out a home loan requires careful consideration. Also, borrowing only what you need is recommended. During this process, it’s tempting to want to get extra money while you’re at it. Most lenders let you borrow up to 85% of your home’s value. But remember, just because you are approved to borrow up to $600,000 doesn’t mean you should. You may be able to go on a nice vacation, but when you get back, your increased mortgage bill will be waiting for you. Not only that, the payback period will be stretched out further and you’ll be paying substantially more interest.
You’ve got options!
Major expenses can come long in a heartbeat. If you suddenly need extra money and have enough equity in your home to take out a loan, you have several choices: a refinance, a cash out refi or a second mortgage. Each option will allow you to tap into the equity in your home, so you can finance your most important goals.
Ready for a second mortgage?
If a big expense is looming, like college tuition, or home improvements and you’re still unsure about how to finance them, we can help. Our team of home equity specialists can help you work out the best option, whether it’s a HELOC or a refi. They’ll guide you through all the pros and cons and develop a personalized repayment plan for you.
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