What is a Second Mortgage? Benefits, Risks, and How It Works (2024)

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• With a second mortgage, you borrow money depending on how much equity you have in your home.
• A home equity loan and a home equity line of credit are both types of second mortgages.
• Use the money from a second mortgage however you want, but be prepared to pay closing costs.

If you need to access a substantial amount of money — maybe to pay down high-interest debt or to make home repairs — tapping into your home equity may be a good way to go about it.

As your home accumulates value and you pay down your mortgage principal, you gain equity in the home. You can use this equity to get a second mortgage and cover large expenses.

Understanding second mortgages

Second mortgages are similar to traditional mortgages, with a few key differences. Here's what to know about them.

Definition and overview

A second mortgage is a type of loan that lets you tap into the equity of your home. If you've paid off a portion of your first mortgage or your home has gained value, you have the opportunity to put the money you have in your home to good use.

Home equity loans and HELOCs — home equity lines of credit — are examples of second mortgages.

How second mortgages work

When you get a first mortgage, you use the money to buy a home. A second mortgage gives you cash to cover other expenses. Both mortgages use your home as collateral, so if you fail to make payments, you risk foreclosure to pay off your mortgages.

You'll still keep your first mortgage. You'll get a second mortgage on top of your initial one, and you'll have two mortgage payments each month.

Taking out a second mortgage is one way to access a large sum of money, and you may find you prefer it to taking out a personal loan or using a credit card.

Benefits of a second mortgage

There are several advantages to getting a second mortgage.These include:

Access to additional funds

Second mortgages let you borrow from your home equity, so depending on how much you have, you may be able to borrow more with a second mortgage than you could with a credit card.

There are also no rules surrounding how you can or can't spend the cash you receive from a second mortgage. You may decide to spend it making major home improvements or enrolling in school. It's probably not a good idea to take out a second mortgage to cover frivolous expenses, though, because you will pay closing costs and interest. But ultimately, it's up to you whether a purchase is worth taking out a second mortgage.

Potential tax benefits

If you decide to use a second mortgage to "build, buy, or substantially improve" your house, then you can deduct the taxes you pay on the loan from your taxable income. This reduces your total tax bill.

Debt consolidation

Second mortgages have fairly low interest rates compared to other products, like credit cards and personal loans. This can make them a smart option for consolidating other debts, as it can reduce the amount of interest you pay over time.

Risks and considerations

Despite their perks, second mortgages aren't without risk. Here are some of the drawbacks you should consider before taking one out.

Increased debt load

Second mortgages are loans, as with any other mortgage. They increase your total debt load and come with a second monthly payment. Make sure you're prepared to handle this extra cost and that it won't put financial strain on your household.

Risk of foreclosure

This is one of the biggest risks of second mortgages. With a second mortgage, you're using your home as collateral. That means if you don't make your payments, your lender can foreclose on your house to pay off the balance.

Interest rates and fees

Although a second mortgage rate is lower than a credit card rate, it's higher than what you'll pay on some other types of loans. Be prepared to pay a higher interest rate on a second mortgage than your initial mortgage. Second mortgages are riskier for lenders, so they charge steeper rates. You'd also pay a lower rate on a regular rate-and-term refinance or cash-out refinance.

Second mortgages also come with closing costs, which you'll need to pay upfront when taking out the loan.

Types of second mortgages

There are two main types of second mortgages: Home equity loans and HELOCs. Here's what to know about these kinds of mortgages.

Home equity loans

With a home equity loan, you receive cash in one lump sum. Then you pay it back in monthly installments over a predetermined amount of time, like 30 years. It's a similar concept as a regular mortgage, except it provides you with cash.

Home equity line of credit

A HELOC works more like a credit card than like a regular mortgage. The HELOC lender gives you a borrowing limit, and you can borrow from that line of credit as needed. Maybe you take out $5,000 to pay off a credit card, then $10,000 later to remodel your bathroom.

As with a credit card, you'll pay back what you borrow, and you can borrow more later. If your borrowing limit is $20,000 and you borrow $10,000, you have $10,000 left to borrow. But if you pay back the full $10,000, your limit is back to $20,000.

Your lender gives you a "draw period," which is a chunk of time you're allowed to borrow money — usually 10 years or less. At the end of the HELOC draw period, you must repay any balance you haven't paid back yet. Read our guide to HELOC pros and cons to learn more.

How to apply for a second mortgage

Applying for a second mortgage isn't much different than applying for a traditional mortgage. You'll find a lender, fill out an application, submit financial documentation, and then close on your loan. See below for more details.

Eligibility requirements

Just as with your first mortgage, you'll need to meet specific requirements to qualify for a second mortgage. Here are the terms you can expect:

• Home equity. You need to have equity in your home to qualify for a second mortgage. Many lenders want you to keep 10% or 20% of your equity after closing on a second mortgage, so take that into consideration before applying.
• Credit score. Each lender is different, but you'll probably need at least a 620 credit score. To improve your credit score before applying for a second mortgage, make sure you're paying all your bills on time. You can also let your credit age and pay down debts.
• Debt-to-income ratio. Your debt-to-income ratio is the amount you pay toward debts each month, divided by your gross monthly income. Lenders usually want to see a DTI ratio of 43% or less for a second mortgage, but again, it depends on the lender. Look into paying down some debts to lower your ratio, or think about any opportunities to earn more money.

If you meet these requirements, you'll need to find a lender who offers second mortgages and reach out to start the application process.

Application process

Most lenders will let you apply for a home equity loan or HELOC online, so once you find your lender, you can start applying right away. You'll need to provide information about your finances, employment, and how much you want to borrow, and you'll need to agree to a credit check, too.

Your lender will also request documentation, things like copies of your driver's licenses, your last two years of tax returns, recent pay stubs and bank account statements, and more.

Approval and funding

Finally, your loan will go through underwriting, and your lender will approve your application. You'll sign your paperwork, pay your closing costs, and get your funds (or access to your line of credit).

Comparing second mortgages with other financing options

Getting a second mortgage isn't the same thing as refinancing a home. When you take out a second mortgage, you tack another mortgage onto your initial one. When you refinance, you replace your first mortgage with a brand-new one that has different terms.

With a second mortgage, you make two mortgage payments each month, one toward the first and one toward the second. With a refinanced mortgage, you just make one monthly mortgage payment.

Second mortgage interest rates are usually higher than mortgage refinance rates, because second mortgages are riskier for lenders. If you were to foreclose on your home, the funds would pay off the original mortgage first, then the second. It's possible the second mortgage wouldn't be paid off in full with a foreclosure. When loans are riskier for lenders, they usually charge higher rates.

There is a type of mortgage refinance that's very similar to a home equity loan: a cash-out refinance. With a cash-out refinance, you borrow against the equity you have in the home and receive cash.

The main difference between a second mortgage and a cash-out refinance is that the latter replaces your first mortgage all together. Cash-out refinances usually charge lower rates than home equity loans or HELOCs, but closing costs are more expensive.

Frequently asked questions about second mortgages