Second Mortgage: Everything Homeowners Should Know

Do you own a home and need a loan for a major expense such as a renovation, repair, paying off a large amount of debt or making a down payment on a second home? Beyond credit cards and personal loans, homeowners have another financing opportunity called a second mortgage. Depending on the equity you have in your home, you may be able to take out a second mortgage using your home as collateral.

We’ll look at what a second mortgage is and how it works. We’ll also dive into the risks and rewards that come with this type of home loan.

What Is A Second Mortgage?

A second mortgage is a lien placed against your home when you have an existing mortgage lien in place. The home is used as collateral to secure the second mortgage. In other words, if you can’t make your payments on your second mortgage, the lender can repossess your home to repay the debt. If you have enough equity, you’ll receive a lump sum of cash or a revolving credit line upon approval, resulting in two mortgage payments.

If you default on your second mortgage, the lender for your first mortgage will be paid back first, which is why it’s called a second mortgage. Since the first lender gets their money first, second mortgages are riskier for lenders. This typically makes interest rates higher for second mortgages than primary mortgages.

Borrowers often pursue a second mortgage to pay for home additions, improvements or repairs that they don’t want or have the money to pay for out-of-pocket. You might also consider a second mortgage for consolidating debt to secure a lower interest rate. Or you might think about using a second mortgage for exactly what it sounds like – buying a second home. This could be an investment property or a vacation home.

Types Of Second Mortgages

There are two main types of second mortgages – a home equity loan and a home equity line of credit (HELOC). Let’s take a closer look at each.

• Home equity loan: A home equity loan is a second mortgage loan using your primary home as collateral. The loan is distributed in a lump sum that you’ll pay back in monthly installments. Interest rates are usually fixed and lower than with an unsecured loan.
• HELOC: This financing option operates as a line of credit you can draw from as needed. You can use this credit line over a certain period of time – called a draw period – that lasts a number of years. Unlike with home equity loans, interest rates on HELOCs are typically variable.

HELOCs can be beneficial if you aren’t sure how much money you’ll actually need. That’s because you don’t have to use the entire amount, and you don’t pay it back until you use it. Home equity loans, on the other hand, are a lump sum you pay back in the full amount. Repayment for home equity loans also begins as soon as you receive the money.

How Does A Second Mortgage Work?

Second mortgages typically require you to have at least 15% – 20% equity in your primary home. You can take out a portion of this equity, with the amount depending on your lender, your home’s value and the remaining balance on your first mortgage. But you can expect to be able to take out around 85% of your home’s value. Determine this amount by calculating 85% of your home’s value and then subtracting the amount remaining on your mortgage.

Let’s say your home is worth $200,000 and you have $100,000 remaining on your first mortgage.

(0.85 X $200,000) – $100,000 = $70,000.

You can expect to be able to borrow around $70,000.

The application process for a second mortgage is similar to applying for any other type of home loan. You’ll shop around for lenders by getting estimates and evaluating the terms to decide which lender is the best fit, and then you’ll apply – typically online. You’ll also gather the necessary documents for your lender, get approved and pay closing costs. Once you receive the funds, you can use them as you wish, and you’ll begin repaying the loan in monthly payments.

Requirements For A Second Mortgage

Before you apply for a second mortgage, you’ll need to know the requirements for one and whether you’ll qualify. Here are the general guidelines, which vary by lender:

Upsides Of Second Mortgages

Taking out a home equity loan or line of credit comes with its advantages, some of which we’ve touched on. Consider these upsides of a second mortgage if you’re still on the fence:

• Second mortgages can provide funds needed for unexpected expenses and emergencies.
• Interest rates for second mortgages are typically lower than other options, such as personal loans and credit cards.
• You can use the money from a second mortgage on whatever you need, with little to no limitations.
• You typically receive the money quickly after approval.
• You can use the funds to pay off debt or consolidate it.
• You may be able to use the funds to purchase an investment property for future passive income.

Downsides Of Second Mortgages

There are also risks associated with taking out a second home loan, including:

• Taking out a second mortgage adds another monthly payment, which can put a strain on your finances.
• Your primary home is at risk. If you can’t make your payments, you could foreclose on your home.
• You’ll have to pay closing costs again.

Second Mortgage FAQs

Looking to better understand a second mortgage as a financing option? Check out the answers to these additional questions that homeowners frequently ask.

When are second mortgages a good idea?

A second mortgage might be a good idea if you have a sizable amount of equity in your first home and you have some wiggle room in the budget for an additional payment. It can also be a wise move if your interest rate is low compared to all other feasible alternatives.

Can I get a second mortgage if I have bad credit?

If your credit score is below 620, your chances of getting a second mortgage aren’t great. If you do qualify with a lower score, you’ll likely have a higher interest rate. A lender might also limit the amount you can borrow based on your credit score.  

What are current second mortgage rates?

Second mortgage rates are higher than interest rates for primary mortgages. That’s because the primary lender gets paid back first in the event of a foreclosure. Rates for second mortgages will sometimes be different from one lender to the next, and they’ll fluctuate based on several market conditions. You’ll get a more accurate idea of your mortgage rate when you receive loan approval.

How many years is a second mortgage?

A second mortgage repayment period is typically 20 years, but it may be more or less time. Some repayment periods can be as short as 5 years, while others can last up to 30 years.

Does a second mortgage hurt my credit?

Getting a second mortgage won’t hurt your credit unless you’re unable to pay back the loan. Missed payments and foreclosure can have a significantly negative impact on your credit score. They can also affect your chances of getting approved for financing in the future.

What are some alternatives to second mortgages?

A cash-out refinance is a popular alternative to a second mortgage. With this option, you receive a lump sum using your home’s equity but your lender pays off the original loan and replaces it with a new loan instead of tacking on an additional one. Other alternatives include personal loans, credit cards and certain types of home improvement loans.

The Bottom Line

Second mortgages are a popular financing option for homeowners who need cash to make home improvements, pay off high-interest debt or even purchase a second home. While a second mortgage can help you access funds in a pinch, it’s important to approach this type of financing option with caution. If you can’t pay back your home equity loan or HELOC, you’ll risk losing your primary home.

Considering a home equity loan? Get the ball rolling with Rocket Mortgage^® and start an application online.