This means that if a worst-case scenario occurs where you can no longer pay your mortgage and the lender sells your home, your first mortgage would be paid first. Your second mortgage would receive any remaining funds after the first mortgage is paid. Second mortgages tap into your home equity, which is the market value of your home less any loan balances. Equity can increase or decrease, but ideally, it grows over time. Equity can change in a variety of ways:
When you make monthly payments on your loan, you reduce your loan balance, increasing your equityIf your home gains value because of a strong real estate market or the improvements you make to your home, your equity increasesYou lose equity when your home loses value or when you borrow against your home
Types of Second Mortgages
A Lump Sum
A standard second mortgage is a one-time home equity loan that provides a lump sum of money that you can use for whatever you want. With that type of loan, you’ll repay the loan gradually over time, often with fixed monthly payments. With each payment, you pay a portion of the interest costs and a portion of your loan balance in a process called amortization.
A Line of Credit
It’s also possible to borrow using a home equity line of credit or a pool of money that you can draw from. With that type of loan, you’re never required to take any money—but you have the option to do so if you want to. Your lender sets a maximum borrowing limit, and you can continue borrowing (multiple times) until you reach that maximum limit. As with a credit card, you can repay and borrow over and over. If you carry a balance, you’ll have to pay interest. Depending on the type of loan you use and your preferences, your loan might come with a fixed interest rate that helps you plan your payments for years to come. Variable-rate loans are also available and are the norm for lines of credit.
What Can a Second Mortgage Be Used For?
Down Payment
Some people use a second mortgage to cover a down payment or even closing fees that they couldn’t otherwise afford. Others take out what is known as a “piggyback” second mortgage to qualify for their main mortgage and avoid paying private mortgage insurance (PMI), even if they don’t have enough cash on hand to make a down payment of 20% on their home. You might qualify for a 10% down payment, 80% of the mortgage, and 10% with a piggyback second mortgage instead of paying 10% of the home value with a down payment and 90% of the remaining value with a mortgage that requires PMI. A second mortgage or a piggyback second mortgage both come with higher interest rates. You could also end up underwater on your loan. Making a down payment of 20% will allow you to avoid paying PMI and qualify for lower interest rates on the first mortgage. You can start your home loan on better financial footing, and can avoid the chance that you might lose your home.
Pay Off Debt
Debt consolidation is a common strategy that involves combining multiple debts into one, often a lower-interest loan. People who have built up enough equity in their homes sometimes take out a second mortgage, so they use their home equity to pay off high-interest debt, but that doesn’t pay off the first debt. Some people consolidate their debts, only to find themselves in debt again within a short amount of time. Taking out a second mortgage to pay off debts puts your home at risk because you’re moving unsecured debt to your home. The lender could foreclose on your property. You could lose it if you couldn’t make your payments. Taking out an extra loan against your home could be a major risk if your home’s value declines to the point that it’s worth less than the mortgage. You would be underwater on your mortgage at this point. You might be more likely to default. It’s better not to tie extra debt to your home if you can avoid it. Speak with a debt settlement company instead to resolve the debt. You might consult a credit counselor to address the problems that caused you to go into debt in the first place. Think about taking out a loan from a bank instead if you decide to consolidate your debt.
Home Improvements and Education
Home improvements and renovations are a common use for second mortgage funds because the assumption is that you’ll repay the loan when you sell your home with a higher sales price. You can also get a tax break for home improvements if you make capital improvements like switching to central air or adding an addition to the house, or if you make energy-efficient improvements. You may be able to set yourself up for a higher income by using a second mortgage for education. But as with other situations, you’re creating a situation where you could face foreclosure. Standard student loans might be a better option.
Pros and Cons of Second Mortgages
Pros Explained
Potentially High Loan Amount
Second mortgages allow you to borrow significant amounts. Because the loan is secured by your home (which is usually worth a lot of money), you have access to more than you could get without using your home as collateral. How much can you borrow? It depends on your lender, but you might be able to borrow up to 80% of your home’s value. That maximum would count all of your home loans, including first and second mortgages.
Potentially Lower Interest Rates
Second mortgages often have lower interest rates than other types of debt. Again, securing the loan with your home helps you because it reduces the risk for your lender. Because the loans are lower-risk, lenders offer lower rates on second mortgages than unsecured personal loans like credit cards.
Tax Benefits If Used for Home Improvements
In some cases, you’ll be able to get a tax deduction for using a second mortgage to “buy, build, or substantially improve your home,” according to the IRS. There are some technicalities to be aware of, so ask your tax preparer before you start taking deductions.
Cons Explained
If Not Repaid, You Risk of Foreclosure
One of the biggest problems with a second mortgage is that you have to put your home on the line. If you stop making payments, your lender will be able to take your home through foreclosure, which can cause serious problems for you and your family. For that reason, it rarely makes sense to use a second mortgage for “current consumption” costs. For entertainment and regular living expenses, it’s just not sustainable or worth the risk to use a home equity loan or line of credit.
Costs and Fees Required
Second mortgages, like your purchase loan, can be expensive. You’ll need to pay numerous costs for things like credit checks, appraisals, origination fees, and more. “Most of the time, a second mortgage—similar to a first mortgage—will come with closing costs,” Lauren Anastasio, a certified financial planner (CFP) with SoFi, told The Balance via email. “You could expect to pay for an appraisal, some type of application or underwriting fee, recording fees, etc. If you’re working with a different lender than the one who holds your first mortgage, you can also expect to pay an additional fee the lender will charge to be in a second lien position. This is like extra insurance for the lender if you default since the lender who holds your first mortgage will basically have first dibs on recouping their losses.” Closing costs can easily add up to thousands of dollars. Even if you’re promised a “no closing cost” loan, you’re still paying—you just don’t see those costs transparently.
More Debt and Interest To Pay
Any time you borrow, you’re paying interest. Second mortgage rates are typically lower than credit card interest rates and unsecured loans, but they’re often slightly higher than your first loan’s rate. Second mortgage lenders take more risk than the lender who made your first loan. And remember, this is more debt that you’ll have to repay. So now you have two mortgages to repay, which could make getting other lines of credit in the future harder.
Should You Get a Second Mortgage?
If you believe you can repay the money you borrow through a second mortgage, then it might be right for you. Second mortgages can help you with down payments and debt, but can also be used for home renovations and education. Consider how you plan to use the funds from your loan. It’s best to put that money toward something that will improve your net worth (or your home’s value) in the future. That is because you’ll need to repay these loans, they’re risky, and they cost a lot of money. Once you decide whether you can afford a second mortgage, take the time to plan out how you’ll use the money. Home improvements may be the best option because you also get a tax break.
How To Get a Second Mortgage
Shop around, and get quotes from at least three different sources. Be sure to include the following in your search:
A local bank or credit union A mortgage broker or loan originator (ask your real estate agent for suggestions) An online lender
You can prepare for the process by getting your documents ready. That will make the process much easier and less stressful. You’ll need information like income, mortgage balance, and more. Ask the lender what they would need before you apply for the loan.
