What is a second mortgage loan? For many homeowners who need cash in short order, a second mortgage in the form of a home equity loan or home equity line of credit is a go-to answer. A second mortgage can help you fund anything from home improvements to credit card debt payoff, and for some, a HELOC serves as a security blanket.
You can probably think of many things you could use a home equity loan or HELOC for, especially when the rate and terms may be more attractive than those of a cash-out refinance or personal loan. Just know that you’ll need to have sufficient equity in your home to pull off a second mortgage. In this guide, we’ll discuss this and more about how to take out a second mortgage and when you might consider it.
Key Points
• A second mortgage allows homeowners to borrow against home equity without refinancing the first mortgage.
• There are two main types of second mortgage: home equity loans (fixed rate) and HELOCs (variable rate).
• Second mortgages can fund major expenses like home improvements or debt payoff.
• Potential risks include the possibility of losing your home if payments are missed.
• Alternatives include personal loans or cash-out refinancing.
What Does It Mean to Take Out a Second Mortgage?
What is a second mortgage loan? It’s a loan secured by your home that’s typically taken out after your first mortgage. Less commonly, a first and second mortgage may be taken out at the same time in the form of a “piggyback loan.”
An “open-end” second mortgage is a revolving line of credit that allows you to withdraw money and pay it back as needed, up to an approved limit, over time. A “closed-end” second mortgage is a loan disbursed in a lump sum.
And since we’re looking at what it means to take out a second mortgage, it’s worth noting that it’s not called a second mortgage just because you probably took it out after your original mortgage. The term also refers to the fact that if you can’t make your mortgage payments and your home is sold as a result, the proceeds will go toward paying off your first home mortgage loan and only then toward any second mortgage and other liens (if anything is left).
How Does a Second Mortgage Work?
A home equity line of credit (HELOC) and a home equity loan, the two main types of second mortgages, work differently but have a shared purpose: to allow homeowners to borrow against their home equity without having to refinance their first mortgage.
Second Mortgage Interest Rates
HELOCs may have lower starting interest rates than home equity loans, although HELOC rates are usually variable — fluctuating over time. Home equity loans have fixed interest rates. In general, the choice between a fixed- vs variable-rate loan has no one universal winner.
Cost of a Second Mortgage
Home equity loans and HELOCs come with closing costs and fees of about 2% to 5% of the loan amount, but if you do your research, you may be able to find a lender that will waive some or all of the closing costs. Some lenders offer a “no-closing-cost HELOC,” but it will usually come with a higher interest rate.
Repayment Terms and Requirements
If you’re wondering how a second mortgage works, that depends. The way you receive funds and repay each kind of second mortgage differs. You generally receive a home equity loan as a lump sum and, since it usually comes with a fixed interest rate, pay it back in equal monthly installments, making it easy to plan for. With a HELOC, you’ll get an initial draw period during which you can take out funds at will, up to a preset limit. You’ll have a minimum payment to make each month but can pay back the principal and draw it out again. During the repayment period that follows, you’ll pay back the loan, generally at an adjustable rate.
To qualify for a HELOC or a home equity loan, you’ll need to have sufficient equity in your home – generally enough so that after you take out the second mortgage, you’ll retain 20% or, at minimum, 15% equity. Lenders’ requirements vary, but typically they will want to see a credit score of at least 620. They will also look at your debt-to-income (DTI) ratio, which compares your monthly debt obligations with your monthly income, and generally will want it to be 43% or lower.
Example of a Second Mortgage
Let’s look at an example of how to take out a second mortgage. Say you buy a house for $400,000. You make a 20% down payment of $80,000 and borrow $320,000. Over time you whittle the balance to $250,000.
You apply for a second mortgage. A new appraisal puts the value of the home at $525,000.
The current market value of your home, minus anything owed, is your home equity. In this case, it’s $275,000.
So how much home equity can you tap? Often 85%, although some lenders allow more.
Assuming that you’re borrowing 80% of your equity, that could give you a home equity loan or credit line of $220,000.
After closing on your loan, the lender will file a lien against your property. This second mortgage will have separate monthly payments.
Types of Second Mortgages
To evaluate whether you qualify for a second mortgage, in addition to seeing if you meet a certain home equity threshold, lenders may review your credit score, credit history, employment history, and debt-to-income ratio when determining your rate and loan amount.
Here are details about the two main forms of a second mortgage.
Home Equity Loan
A home equity loan is issued in a lump sum with a fixed interest rate. Terms may range from five to 30 years.
Recommended: Exploring the Different Types of Home Equity Loans
Home Equity Line of Credit
A HELOC is a revolving line of credit with a maximum borrowing limit.
You can borrow against the credit limit as many times as you want during the draw period, which is often 10 years, as long as you keep the funds sufficiently replenished. The repayment period is usually 20 years.
Most HELOCs have a variable interest rate. They typically come with yearly and lifetime rate caps.
Piggyback Loan
A piggyback loan is a second mortgage you take out at the same time as your first mortgage in order to help fund your down payment so you can avoid paying private mortgage insurance (PMI). People generally have to pay PMI when they buy a home and make a down payment on a conventional loan of less than 20% of the home’s value.
Here’s how it works, if you have only a 10% down payment, you might take out a mortgage for 80% of your purchase price and a piggyback loan, typically at a higher and probably variable rate, for 10% of the purchase price to put toward your down payment so you’ll have the full 20%.
Second Mortgage vs Refinance: What’s the Difference?
A mortgage refinance involves taking out a home loan that replaces your existing mortgage. Equity-rich homeowners may choose a cash-out refinance, taking out a mortgage for a larger amount than the existing mortgage and receiving the difference in cash.
Taking on a second mortgage, on the other hand, leaves your first mortgage intact. It is a separate loan.
To determine your eligibility for refinancing, lenders look at the loan-to-value ratio, in part. Most lenders favor an LTV of 80% or less. (Current loan balance / current appraised value x 100 = LTV.)
Even though the rate for a refinance might be lower than that of a home equity loan or HELOC, refinancing means you’re taking out a new loan, so you face mortgage refinancing costs of 2% to 5% of the new loan amount on average.
Homeowners who have a low mortgage rate will generally not benefit from a mortgage refinance when the going interest rate exceeds theirs.
Pros and Cons of a Second Mortgage
What does it mean to take out a second mortgage, all in all? It’s a big decision, and it can be helpful to know the advantages and potential downsides before diving in.
Pros of a Second Mortgage
Relatively low interest rate. A second mortgage may come with a lower interest rate than debt not secured by collateral, such as credit cards and personal loans. And if rates are on the rise, a cash-out refinance becomes less appetizing.
Access to money for a big expense. People may take out a second mortgage to get the cash needed to pay for a major expense, from home renovations to medical bills.
Mortgage insurance avoidance via piggyback. A homebuyer may take out a first and second mortgage simultaneously to avoid having to pay private mortgage insurance (PMI) if they have less than 20% for the down payment for a conventional mortgage. A piggyback loan, or second mortgage, can be issued at the same time as the initial home loan and allow the buyer to meet the 20% threshold and avoid paying PMI.
People generally have to pay PMI when they buy a home and make a down payment on a conventional loan of less than 20% of the home’s value.
A piggyback loan, or second mortgage, can be issued at the same time as the initial home loan and allow a buyer to meet the 20% threshold and avoid paying PMI.
Cons of a Second Mortgage
Potential closing costs and fees. Closing costs come with a home equity loan or HELOC, but some lenders will reduce or waive them if you meet certain conditions. With a HELOC, for example, some lenders will skip closing costs if you keep the credit line open for three years. It’s a good idea to scrutinize lender offers for fees and penalties and compare the APR vs. interest rate.
Rates. Second mortgages may have higher interest rates than first mortgage loans. And the adjustable interest rate of a HELOC means the rate you start out with can increase — or decrease — over time, making payments unpredictable and possibly difficult to afford.
Risk. If your monthly payments become unaffordable, there’s a lot on the line with a second mortgage: You could lose your home.
Must qualify. Taking out a second mortgage isn’t a breeze just because you already have a mortgage. You’ll probably have to jump through similar qualifying hoops in terms of home appraisal and documentation.
Common Reasons to Get a Second Mortgage
Typical uses of second mortgages include the following:
• Paying off high-interest credit card debt
• Financing home improvements
• Making a down payment on a vacation home or investment property
• As a security measure in uncertain times
• Funding a blow-out wedding or other big event
• Covering college costs
Can you use the proceeds for anything? In general, yes, but each lender gets to set its own guidelines. Some lenders, for example, don’t allow second mortgage funds to be used to start a business.
Funding Major Home Improvements
Building a garage or upgrading your kitchen are the kind of home improvements you could fund with a second mortgage. What’s more, if you itemize your federal taxes, some or all of the interest you pay on your second mortgage may be tax deductible if it’s used on home improvements. Consult with your tax adviser for the most up-to-date information.
Covering Education Expenses or Debt Consolidation
Getting a better interest rate on debt is a significant reason many people take out second mortgages. A second mortgage, especially a HELOC, can be an appealing way to finance education. Typically, its rates are lower than those of private student loans. Still it’s worth looking into federal loans, which may have even lower rates and don’t put your home at risk if you default.
Consolidating debt is another reason people take out second mortgages. Rather than paying often hefty credit card rates, for example, you could take out a second mortgage, pay off the high-interest debt, and pay back the second mortgage at a more reasonable rate over time. You can also use a home equity loan in particular to pay off multiple debts so that you’ll just have one predictable bill each month.
How to Get a Second Mortgage
If you’ve decided that a HELOC or home equity loan is the right choice for you, here’s how to get a second mortgage. Begin by assessing what you need and evaluate how much you can afford in payments each month.
Next, review typical requirements and evaluate how well you match up. Remember that requirements may vary somewhat from lender to lender.
After you’ve brushed up your credentials, start researching lenders. You might be able to get a slightly lower rate from the lender who provided your primary mortgage, but it’s worth looking around at the options and negotiating terms. Take into account whether you have enough to pay for closing costs or whether you’ll need to look for a no-closing-costs option or a lender who will waive the fees.
Once you’ve made a decision, submit your application If you’re approved, the lender will likely want to conduct an appraisal of your property. If all goes well, you’ll soon be signing papers and closing your loan.
The Takeaway
What’s the point of a second mortgage? A HELOC or home equity loan can provide qualifying homeowners with cash fairly quickly and at a relatively decent rate. If you prefer not to have a second mortgage, you may want to explore a cash-out refinance, which is another way to put some of your home equity to use.
Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.
FAQ
Is a HELOC a second mortgage?
Perhaps you’ve been wondering, “Is a HELOC a second mortgage?” The answer is yes: A HELOC (home equity line of credit) is one kind of second mortgage. It’s a revolving line of credit, but it is secured by your home, just as your mortgage is, and if you default on it, you risk losing your home.
Can you refinance a second mortgage?
You may be able to refinance a second mortgage, either on its own or in combination with your primary mortgage. If you’re interested in the combination refi, one major factor that determines whether you can refinance a second mortgage along with the first is whether you’ll have the 20% equity typically required.
Does a second mortgage hurt your credit?
You may be wondering, “What does it mean to take out a second mortgage when it comes to your credit?” Shopping for a second mortgage can cause a small dip in an applicant’s credit score, but the score will probably rebound within a year if you make on-time mortgage payments.
How much can you borrow on a second mortgage?
Many lenders will allow you to take about 85% of your home equity in a second mortgage. Some allow more.
How long does it take to get a second mortgage?
Applying for and obtaining a HELOC or home equity loan takes an average of two to six weeks.
What are alternatives to getting a second mortgage?
A personal loan is one alternative to a second mortgage. A cash-out refinance is another.
Can you have multiple second mortgages?
In theory you can have more than one second mortgage on the same property, but in practice it may be difficult. Lenders may subject your application to extra scrutiny or simply have a policy against it. If you buy a vacation property, it may be possible to get a second mortgage as well as a primary mortgage loan for the second home in addition to your primary and secondary mortgage on your primary residence.
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