A second mortgage is a loan that allows borrowers to access some of their home equity without refinancing or selling their homes.
The second mortgage is separate from your original mortgage, meaning that your primary mortgage is unaffected. The second loan is taken out against the original loan, and the funds can be used for any purpose.
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In this article, we’ll answer the question, “What is a second mortgage?”, by taking a look at how this type of loan works, the requirements and the pros and cons.
What is a second mortgage?
A second mortgage is an additional loan secured by your existing home.
It’s called a second loan because it’s second in line to be paid off, while your original mortgage is first.
To qualify for a second mortgage, the borrower should have sufficient home equity.
Calculate your home equity by subtracting your current mortgage balance from your home’s value. A second mortgage allows borrowers to tap into a portion of this equity and use it for whatever purpose they choose.
Home equity loans (HELs) and home equity lines of credit (HELOCs) are two of the most common types of second mortgages.
Home equity loan
Home equity loans generally have fixed rates. Borrowers receive the funds as a lump sum that is repaid over a set term.
Home equity line of credit
A HELOC usually has an adjustable rate and works much like a credit card. Borrowers can draw funds as needed and repay the balance over time.
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How does a second mortgage work?
Homeowners build equity as they repay their primary mortgage. Equity can also increase over time as the home’s value increases.
Equity stays locked up in any home unless the borrower taps into it with a second mortgage, cash-out refinance or home sale.
Second mortgages allow homeowners to access their equity without altering their first mortgage.
For example, if a homeowner chose to refinance today, they would have to give up their current mortgage rate and terms in exchange for a new rate and terms.
This isn’t a bad thing when rates are dropping; but in a market where mortgage rates are on the rise, most borrowers will want to avoid any change in their current rates.
Second mortgages usually have slightly higher rates than first mortgages because the lender is taking on additional risk, but the rates are often lower than those of personal loans or credit cards.
Borrowers will need to meet certain lender requirements to qualify for a second mortgage just as they did with their first mortgage.
Requirements for a second mortgage
The general process starts with applying for the loan. Then, you will need to provide income and employment documentation. You’ll also need to get an appraisal to confirm your home’s value and the amount of equity you actually have.
The amount of equity required varies from lender to lender, but most lenders require that you have at least 20% equity in your home and will allow you to borrow up to 85% of your home’s value.
You also will need to meet a credit score of 630 and debt-to-income ratio of 45% or less.
How can a borrower use the funds from a second mortgage?
Borrowers have the freedom to use a second mortgage in whichever way they choose.
Some common second mortgage uses include:
- Home improvements or renovations
- Paying off high-interest debts, such as credit cards
- Avoid refinancing and losing your current rate and terms
- Refinance and eliminate the need for mortgage insurance
- Put a down payment on a second home
- Pay for a large expense, such as college or a wedding
A second mortgage can be helpful in a range of situations, but it’s not always the right choice. Some borrowers may be better off with a cash-out refinance.
Let’s take a look at the differences between a second mortgage and a cash-out refinance.
Second mortgage vs. cash-out refinance
A second mortgage is another lien to your property, meaning you will have two separate loans to repay each month.
Second mortgages do not affect the first mortgage, so the terms of the first mortgage will not change nor will there be any impact on the original loan in any way.
A refinance replaces your original loan with a new loan. Borrowers can get a new loan from a different lender and switch up the loan terms, loan type or interest rate.
A cash-out refinance allows borrowers to tap into their home equity. Borrowers will take out a new, larger loan. The difference between the new loan and the previous mortgage balance is paid to the borrower in cash.
Second mortgage vs. home equity loan
Home equity loans and home equity lines of credit are both second mortgages. Sometimes people confuse the two or believe that second mortgages are a different type of loan than equity loans.
Home equity loans and HELOCs work differently, but they both tap into the owner’s equity in an existing property.
Pros and cons of a second mortgage
As with any loan type, there are certain benefits and drawbacks that each borrower must consider.
Let’s take a look at the biggest pros and cons of second mortgages.
- You don’t have to touch your first mortgage
- You may be able to access tax benefits if you use the funds for home improvements
- The interest rates are more favorable than credit cards or personal loans
- Access to potentially larger amounts of cash for whatever purposes you choose
- Your home is at risk if you can’t repay the second mortgage
- Closing costs and fees
- You’ll have to meet certain lender requirements to qualify
- Slightly higher interest rates than you would on a first mortgage
The decision to get a second mortgage is a personal financial decision that must align with your current and future homeowner goals.
The best way to determine which loan type is best for you is to connect with a reputable, trustworthy lender with experience in second mortgages, like Compass Mortgage.
Apply for a second mortgage at Compass Mortgage
Home equity loans and HELOCs can help borrowers tap into their home equity to pay for home improvements, invest in another property or even pay for a child’s college tuition.
If you’re ready to unlock the invaluable equity in your home, you need the right lender to advocate for your needs and help you through the lending process.
Start the home equity loan process today with Compass Mortgage.
We are home to a better, more human mortgage experience, treating our customers like family and value their unique financing needs.
Together we’ll find the most affordable loan for your home, backed by the convenience and power of technology.
Photo by Ketut Subiyanto