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A second mortgage is a type of home loan—like a home equity loan—a lender approves in addition to an original mortgage that has not yet been paid off. Using a second mortgage, homeowners can borrow against the equity they have in their houses, often at rates that are lower than other types of financing.
What Is a Second Mortgage?
A second mortgage is a lien that’staken against a house when a new loan is issued and a first loan is still outstanding. Second mortgages are separate loans that have their own applications, closing costsand monthly payments.
Second mortgages allow homeowners to borrow against the equity in their homes without having to refinance the first mortgage. Using a second mortgage, you borrow up to 85% of your total home value (minus the amount owed on a first mortgage) for as little as 2 percentage points over prime rate, plus closing costs. Keep in mind that lenders expect you to have about 20% equity in your home before they’ll approve a second mortgage.
How a Second Mortgage Works
Along with a separate application process, underwriting and loan closing, second mortgages also require you to make separate payments each month in addition to your normal mortgage payments.
When a lender gives you a second mortgage, the lender takes a lien against your property, which is subordinate to your first mortgage. This means that if you later default on either of your mortgages and one of your lenders has to foreclose, the lender that issued your first mortgage gets paid before the issuer of the second. This structure makes second mortgages riskier for lenders, so rates typically are higher.
Second Mortgage Example
Imagine you buy a house for $200,000. You make the recommended 20% down paymentof $40,000 and borrow $160,000. Next, you pay down your loan over several years and now have a balance of $120,000.
Now, let’s sayyou want to renovate part of your home by borrowing against your home’s equity. Using a second mortgage, most lenders will let you borrow up to 85% of a property’s value—so you apply for a second mortgage.
Because you bought your house a few years ago, your lender requires a new appraisal. Theappraiser estimates the value of the home to be $210,000, so subtracting your balance of $120,000, that means you now have $90,000 in equity in your home. Assuming you have good credit and sufficient income to cover the cost of your loan, you may be able to borrow up to $76,500 using a second mortgage.
After closing on your loan, your lender files a lien against your property, similar to your first mortgage; but, this is a separate loan, with a separate lien and separate monthly payments.
Types of Second Mortgages
Second mortgages come in many shapes and sizes, depending on the lender you work with. But, generally, these loans fall into one of two categories: home equity loans and home equity lines of credit.
- Home equity loan.With a home equity loan, all of the loan funds are provided upfront in one lump sum. Then, the borrower makes equal monthly payments consisting of both principal and interest until the loan is paid off at the end of the term. This type of loan comes with a fixed rate.
- Home equity line of credit(HELOC).Using a HELOC, lenders take a lien against the property upfront, but the borrower has the option of borrowing available funds over time when needed. Then, the borrower makes regular monthly payments that are usually interest-only during what’s called the draw period, about 10 years. When the draw period ends, the repayment period begins, and the borrower must make monthly principal and interest payments. This type of loan comes with a variable rate.
Second Mortgage Costs
Second mortgages have costs—both upfront costs that often total 2% to 5% of the loan amount, and costs paid over time. Many of these costs are the same as primary mortgages, but are assessed and paid separately, as these are separate loans. Quite often, they’re even issued by different lenders.
Some of the costs of second mortgages include:
- Origination fees (often 1% to 2% of the loan amount)
- Interest (rates typically start at prime plus 2%)
- Title work and documentation preparation fee (usually a few hundred dollars to $1,000)
- Appraisal fee (if you need a new appraisal, you’ll probably pay a couple hundred dollars for one)
Reasons to Get a Second Mortgage
People get second mortgages for all types of reasons. Sometimes, they want to add on to their house or make other improvements. Other times, they want to access the equity in their home to start or buy a business (second mortgages can be cheaper than business loans). Sometimes, they want to take a nice vacation or finance a large purchase.
Some of the most common reasons people get a second mortgage are:
- To make improvements to property
- To invest in a business
- To pay off higher-interest debt
- To finance a vacation, wedding or other large purchase
Advantages of a Second Mortgage
- Don’t have to refinance your first mortgage
- Don’t always have to get a new appraisal
- May be able to draw money over time and only pay interest on what you borrow
- Good way to build your credit if you pay on time
- Loans are often cheaper than other types of debt
- Some loans are interest-only, which makes them cheaper
Disadvantages of a Second Mortgage
- Have to pay origination fees on new loan
- May need to pay for a new appraisal
- Reduces the equity in your home
- Debt may have to be paid off in a lump sum if lender doesn’t renew your loan
- Increase your monthly debt load
Steps to Get a Second Mortgage
The steps for getting a second mortgage are much the same as getting a first mortgage when you buy a house—the key difference with second mortgages is that you already own the property.
Borrowers who want a HELOC or home equity loan should follow five basic steps:
- Choose a lender.If you already have an existing relationship with a bank, that’s usually the first place to look.
- Apply for a loan.Each lender has its own application process, with different documentation requirements.
- Provide personal financial information.Your lender will want to see a good deal of information about your financing, including pay stubs and usually two years of tax returns.
- Submit to appraisal and inspections as necessary.If your property hasn’t been appraised in the last three to six months, your lender will likely want to get a new appraisal and may even want to inspect the property.
- Close and secure loan proceeds.Once your loan is approved, you can close on the loan and get access to your funds.
It’s also important to note that different lenders have different fees they charge throughout the loan process. Some lenders have application fees they charge upfront, while others have appraisal or title fees that don’t get paid until the loan closing. In some cases, you even can finance these closing costs. Just know those costs will be tacked on to the balance of your loan when you close—and you’ll be paying interest on those fees throughout the life of the loan.
