Second Mortgage

Second Mortgage
A second mortgage occurs when a borrower with an existing mortgage loan takes out a second one. As with the first mortgage, the borrower’s home is used as collateral.

What is a Second Mortgage?

A second mortgage is a mortgage loan, and as with any mortgage loan, it is secured by a borrower’s home. Borrowers take out a second mortgage when they already have a mortgage but need a second one to pay for another large purchase.

A borrower’s first mortgage loan was probably used to make a home purchase. Because of this, the second mortgage is typically unrelated to real estate. Some borrowers use a second mortgage to make a car purchase or to consolidate high-interest loans, for instance.

How do Second Mortgages work?

With second mortgages, borrowers will need to have their home appraised. Since the home will serve as collateral for the loan, the lender will want to ensure that the property will cover the cost of a default.

If the lender chooses to offer a loan, the amount will be based on the equity that the borrower has in the home. Equity is how much of the home the borrower owns, so a borrower who has paid $60,000 on a $100,000 home, for instance, has a home equity of $60,000. Most lenders limit second mortgage loan amounts to 80 to 90 percent of the home’s equity.1

What are the different types of Second Mortgages?

Borrowers can choose from two basic types of second mortgages: lump sum and line of credit.

A lump sum second mortgage—also called a “home equity loan”—is when the borrower receives the loan in a single lump sum. The borrower repays the loan in regular installments over a set period of time.

The second type of second mortgage is a line of credit—also called a “home equity line of credit,” or HELOC—which is similar to using a credit card. Borrowers are given a credit limit, and they can borrow up to that amount. Borrowers are only responsible for paying back what they actually take out.

Where do I apply for a Second Mortgage?

Second mortgages can be found through the same types of lenders as regular mortgages. Banks, credit unions, and dedicated mortgage lenders all offer them. Lenders will have different interest rates, closing costs, penalties, and payment options, so borrowers are encouraged to shop around.

Are Second Mortgage rates higher than first mortgage rates?

Second mortgages typically come with a slightly higher interest rate than first mortgages. This is because second mortgages present more risk to lenders. If a borrower defaults, profits from the collateral will go toward the outstanding balance on the first mortgage. The lender who provided the second mortgage will only be paid after the first mortgage is covered.2

How much can I afford to borrow with a Second Mortgage?

A second mortgage is a loan like any other, and because of this, what borrowers can afford depends on their unique financial situation. Borrowers might want to consult a loan calculator so they have a clear understanding of how much the loan will cost.

Whether a second mortgage is affordable also depends on what the borrower purchases with the loan. Buying a house or a car, for instance, will come with additional costs such as insurance or taxes. Borrowers can use a mortgage calculator or an auto loan calculator to determine how much of a loan they can afford.

Why get a Second Mortgage?

A second mortgage will provide a borrower with a large amount of money. If used responsibly, a second mortgage can allow borrowers to make a necessary purchase that they otherwise wouldn’t be able to afford. However, like all loans, they come at a risk. If someone is already in a tough financial situation, a second mortgage, and the added cost of payments it would create, can make matters worse.

A major risk of second mortgages is that borrowers run the risk of losing their home. If the loan isn’t repaid, the lender can foreclose on the property. Borrowers should exercise caution when considering a second mortgage.

References:

1 Geffner, Marcie. (2015, July 31). How much equity can you cash out of your home? Retrieved from http://www.bankrate.com/finance/home-equity/how-much-equity-can-you-cash-out-of-home.aspx

2 Pritchard, Justin. (2016, October 14). Second mortgages – advantages and disadvantages. Retrieved from https://www.thebalance.com/second-mortgages-advantages-and-disadvantages-315697