How Does a Second Mortgage Work?
A second mortgage can help you finance large purchases using the equity in your home.
Written by Heather Bernhard
Reviewed by Melanie Reiff
A second mortgage is a loan secured for a property in addition to your primary mortgage. You can use a second mortgage to generate a large sum of money, which can help finance an education or pay for an expensive divorce.
Second mortgages are often confused with mortgage refinances—but although both can help generate some extra cash, they have a few important differences.
When you’re looking for financing options, industry jargon can be tricky. So, home and
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What is a second mortgage?
A second mortgage is a loan taken out against a property that already has an existing mortgage.
If you are still paying off your first mortgage, you can take out this additional loan using your home as
collateral
. If you don’t make the payments on your second mortgage, the lender has the right to foreclose on your home. However, all proceeds will go to the original mortgage lender until that loan is paid off, and the second lender will get any remaining funds.
Because lenders take on more risk in issuing second mortgages than standard mortgages, interest rates tend to be higher and loan amounts tend to be lower with second mortgages.
That said, the interest rates are still typically lower than the interest on your credit card—and you can use the funds from a second mortgage for almost anything you want, from buying a new car to funding a fancy vacation.
MORE: The best home emergency insurance
How does a second mortgage work?
To get a second mortgage, you’ll typically need to meet the same requirements you met for your first mortgage. That means your
credit score
needs to be in good shape, you can’t have too much debt
, and you need proof of income
. Because second mortgages are based on the amount of
equity
you have in your home, you may also have to get an appraisal to confirm its value. This home equity requirement is the key difference between a first and second mortgage.With a first mortgage, a person takes out a loan with the home they purchase acting as collateral. Over time, they make continual payments and build equity as the percentage of the home paid off increases.
Your second mortgage is taken out against that equity. The money is available immediately as a lump-sum payment and can be used on any expenses you choose.
As with a standard mortgage, you must repay the second mortgage over a specified term at a fixed or variable interest rate. Additionally, you must pay off the second mortgage before you can take out another loan using their home equity as collateral.
Pro Tip A second mortgage lender will allow you to borrow against a portion of your home equity, so you still have some available (usually at least 20% of your home’s value).
Difference between a second mortgage and refinance
People may use the terms “second mortgage” and “refinance” interchangeably, but they are two very different things.
A second mortgage uses the equity you’ve built in your home to secure a loan or line of credit. This puts you further into debt—potentially quite a bit. Like with a first mortgage, you must make regular, monthly payments until the debt is paid in full (and likely at a much higher interest rate).
A mortgage refinance is an additional loan taken out to make it easier to pay off your first mortgage. The refinance loan is more money than the original mortgage is worth, and you’ll receive the difference between the existing mortgage and the new mortgage in one lump-sum payment.
Typically, borrowers refinance if the current market offers better interest rates than when they first took out the mortgage.
Common uses for a second mortgage
You can use funds from a second mortgage for various purposes, depending on your financial situation. Often, borrowers take a second mortgage to consolidate high-interest debt or to finance home repairs.
Other uses may include:
- Financing a college education
- Paying off medical bills
- Paying for big purchases, such as new furniture or a car
Types of second mortgages
People who take out second mortgages usually choose between home equity loans and home equity lines of credit. Here are the differences:
Home equity loans
A home equity loan is secured with the equity in your home, and you receive a one-time, lump-sum payment. You repay it at fixed intervals, and your payment will remain the same each month unless you have a variable interest rate.
Typically, you need good credit to get a home equity loan, though bad-credit options are available at higher interest rates.
Home equity line of credit (HELOC)
A home equity line of credit (HELOC) is similar to a credit card: you can borrow money, repay it, then use the line of credit to borrow again. You can take as much as you need up to a fixed limit set at the beginning. As you pay down your balance, the available credit is replenished.
Like a home equity loan, the line of credit is secured using your home equity. Interest rates are variable, and the draw period can last up to ten years.
Some lenders only require you to pay off the interest during the draw period, after which time you’ll enter the repayment phase and have to make payments toward the interest and principal.
During the repayment phase (which can last up to 20 years), you must pay off the principal and interest, and payment amounts can jump drastically. As with a home equity loan, the lender can foreclose on your property if you fail to pay back your HELOC.
How to apply for a second mortgage
You must apply for a home equity line of credit or home equity loan. Requirements are much the same as for a first mortgage: you’ll need to provide documentation verifying your income and debts, and you must have a credit score of at least 620.
Most lenders require that you have at least 15% to 20% equity in your home, which means you can borrow up to 85% of your home’s value. For example, if your home is worth $350,000, you may get a home equity loan of up to $297,000.
You’ll also need to apply for an appraisal of your property, which could take weeks to complete—and makes it difficult to estimate how long it will take to receive a payout.
Your best bet? If you know you have a significant expense coming up and may want to take out a home equity loan, get all of your financials in order now. That includes checking your credit report for any errors, reducing your debt-to-income ratio if possible, and paying for an appraisal.
Pro Tip Don’t settle for the first lender that offers you a home equity loan. Instead, get quotes from several institutions, including banks and credit unions, and compare them in detail. Then, choose the lender that offers you the best terms.
Is a second mortgage right for me?
Before you apply for a second mortgage, consider the risks. While attractive, a home equity loan might not be best for everyone’s financial situation.
Pros
- Interest rates on second mortgages are typically lower than most credit cards
- Second mortgages allow you to access unused equity in your home
- The interest paid on mortgages may be tax-deductible
Cons
- Closing costs can run about 3% to 6% of the total loan amount
- If you default on payments, the bank can foreclose on your home
- You may not qualify for the amount you want if your equity isn’t high enough or your credit isn’t up to par
- If your home depreciates, you may end up owing more than it’s worth
Ultimately, the best reason to take out a second mortgage is to improve your home. If the appraisal value increases, your equity will essentially replenish itself.
Key Takeaway Think again if you’re planning on taking a second mortgage to pay for a vacation, car, or another luxury item. If you end up not being able to make payments or your home depreciates, and you lose equity, the loan will do your finances more harm than good.
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Can you get a second mortgage to buy a second house?
Yes, you can use a home equity loan or line of credit to buy another house. However, doing so will put your current home at risk. If you default on the second mortgage, the lender may foreclose on your primary residence.
How do you refinance a second mortgage?
You can refinance your second mortgage, your first mortgage, or both! Doing so may lower interest rates and lead to smaller monthly payments.
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