Second Mortgage: What You Need to Know
There are many reasons to tap into your home equity. Maybe you’re looking to buy another home, or need to avoid paying for PMI? Getting a second mortgage may be the answer, but before you commit, you’ll want to know the benefits and disadvantages so you can make the best choice about how to secure funding.
What Is a Second Mortgage?
When it comes to determining who has the rights to the value of a home, an order is established based on the position of the loan. The first mortgage, usually the larger of the two, is in the senior position. This means that if you were to default on your loan, and the home was sold at a foreclosure sale, the proceeds of that sale would go to the holder of the lien in first position.
A second mortgage is a lien that holds a subordinate position to the first. Before the holder of this lien receives any proceeds, the first mortgage must be paid in full. This makes the second mortgage a riskier loan for lenders, and consequently, they often come with a higher interest rate. Additionally, if you wanted to do something like refinance your first mortgage but leave the second in place, you would need approval from the holder of your second mortgage to allow a new lender to step into the first lien holder position. In most situations, the lender will likely want you to refinance both the first and second mortgages together.
Types of Second Mortgages
Second mortgages come in four different types, and each offers its own benefits.
- Junior mortgage: Any mortgage or loan secondary to the original mortgage on a home.
- Home Equity loan: Funding as a lump sum against accumulated equity.
- Home Equity Line of Credit: Funding the form of a revolving line of credit against accumulated equity on the home.
- Piggyback mortgage: Funding acquired simultaneously with the original mortgage, as a way to avoid paying PMI.
7 Reasons to Get a Second Mortgage
There are many reasons to get a second mortgage. Here are seven to consider:
- Home improvements: Renovations and improvements not only improve your home but also add value, and an equity loan can help with funding renovations. If this interests you, check out our ultimate guide to home improvements.
- Plastic surgery: Using a second mortgage to pay for plastic surgery is one of many options you may consider for financing.
- Teacher-next-door: This home buying program allows teachers to buy a home at a discounted 50% of the market value. The discounted price becomes a silent second mortgage that requires no payment, and no interest is accrued as long as the buyer meets a 36-month residency requirement.
- Good-neighbor-next-door: Like the program above, teachers, firefighters, and law enforcement are all able to buy homes at a discounted price, which becomes a secondary mortgage with no payment required. There are a number of other home buying programs, if you or someone you know is looking to buy a home.
- Start-up business: Launching a business requires funding, which funds from a second mortgage may provide.
- Wedding: Paying for a wedding shouldn’t overshadow the happiness of the event. Allow an equity loan to help out.
- No-PMI: If you have a small down payment, you have to pay PMI. Or do you? Check out a piggyback loan to see if it’s right for you.
How Much Money Can You Get?
Everyone wants to know how much money they can get with a second mortgage. No matter the type you choose, how much you can borrow is dependent on the amount of equity you have in your home. If you’re looking to get a HELOC or an equity loan, here is a calculator for estimating the funds you may be able to receive. Keep in mind that most banks will not allow you to borrow 100% of your equity. A more reasonable expectation is around 80%, although some banks will go as high as 90%. Banks will also use your loan-to-value ratio (LTV) for qualification. The lower your LTV, the better.
Advantages and Drawbacks
Each type of second mortgage comes with its own pros and cons. For example, there are many pros and cons to home equity loans. HELOC’s also come with a great advantage: they can be used as an alternative to credit card debt. Here are a few more things to consider:
- Quick access to cash. If you need money now, many of the vehicles you can use for a second mortgage will allow you to quickly access the cash available in your home and start putting it to use right away.
- Low interest rates. Compared to credit card interest rates, home equity loans and other secondary financing options offer very attractive rates.
- Improve the value of your home. If you do it right, taking out a second mortgage to make renovations to your home can really increase the value of your home, make it more comfortable to live in, and easier to sell.
- Putting your home at risk. The greatest drawback to a second mortgage, whether it’s an equity loan or a HELOC, is that your home is collateral. If your finances change, and as a result, you start missing payments, you risk foreclosure. Because your home secures your loan, the bank may seize your home if your second loan goes into default and sell it to pay off what you owe.
- Fees. Whenever you originate a loan, you can expect to pay fees. With a second mortgage, you may expect to pay fees associated with getting an appraisal, applying for the loan, and closing on the loan. All those fees can really start to add up.
- More debt. The equity in your home should be guarded carefully and shouldn’t be used frivolously. But no matter how you spend the money, a second mortgage amounts to more debt, with more interest paid. So use caution when deciding when and how to use it.
How to Comparison Shop
When you’re looking at get a second mortgage, doing some comparison shopping is a good idea. Here are five steps to assure you’re getting the best deal:
- Print out this comparison shopping worksheet. You may use it for comparison shopping for a home equity loan or line of credit.
- Create a list of lenders you want to contact.
- Contact all the lenders on the same day (because rates change daily),and get a baseline for what’s being offered.
- Use the worksheet to compare offers.
- Choose the best offer for you.
Is a Second Mortgage Right for You?
There are lots of ways to leverage your home equity. Whether a second mortgage is the way to go will depend on the equity you have in your home and your financial situation. If you’re unsure, use our home equity calculator to determine how much equity you have in your home. If you have enough equity to qualify, and are able to pay for the second mortgage payment on top of your first payment, then this may be one of the best options for securing extra funding.
If you don’t have enough equity or your financial situation is such that making payments would create financial stress, then getting a second mortgage may not be the best option at the moment, and you’ll need to consider other alternatives.