What is a second mortgage?
A second mortgage is an additional home loan you take out against a property you already have a mortgage on, using your equity as collateral. Equity is simply the difference between what you owe on your mortgage and the current value of your home. When you need money to cover some of life’s big (or unexpected) expenses, it can be a valuable resource.
For example, say your home is worth $500,000 and you owe $200,000. That leaves you with $300,000 in equity. Depending on the lender, you may be able to borrow up to a certain percentage of that amount. That second loan becomes your second mortgage.
A second mortgage is sometimes called a second lien or a “junior lien.” That’s because if you ever can’t repay both loans and the home is sold to pay the debts, your first mortgage lender gets paid back before your second. A lien is the lender’s legal claim to your property, and it gives the lender the right to foreclose on the home if you fall too far behind on your payments.
How does a second mortgage work?
When you take out a second mortgage, the lender lets you borrow against a percentage of your equity, often up to a certain loan-to-value (LTV) ratio. Many lenders prefer you to keep at least 15% to 20% equity in your home, so you usually can’t borrow against every dollar of available equity.
A second mortgage isn’t a refinance. It’s a totally new mortgage, which means you have a second monthly payment on top of your existing mortgage. You’re responsible for both, and missing payments on either one carries real risk since your home is collateral for both.
Interest rates on a second mortgage may be a bit higher than your first mortgage, since the lender takes on more risk by being second in line (even if they’re providing both loans). The upside? Rates are usually lower than those for unsecured options like credit cards or personal loans, because your home backs the loan. Factors like your credit score, your debt-to-income ratio and the amount of equity you have can all play a role in your interest rate offer.
Why would you get a second mortgage?
People take out a second mortgage for all kinds of reasons. Some common ones include:
- Funding home renovations or repairs
- Consolidating higher-interest debt into a single payment
- Covering a major expense like medical bills or tuition
- Paying for a large, planned purchase, such as a second home or investment property
Since the funds are flexible, you can generally use them for nearly any purpose. Just keep in mind that your home is part of the equation, so it’s worth borrowing thoughtfully.
Types of second mortgages
There are two main types of second mortgages, and each fits a different kind of need.
Home equity line of credit (HELOC)
A home equity line of credit, or HELOC, works a lot like a credit card. Instead of getting all your money upfront, you get a revolving line of credit you can draw from as needed, up to a set limit.
HELOCs usually have a draw period, typically 10 years, during which you can draw funds and make interest-only payments. After that comes the repayment period, when you pay back the principal plus interest. One thing to watch: HELOCs typically have variable interest rates, so your payments may rise or fall over time.
A HELOC may be a good fit when you’re not sure exactly how much you’ll need or when your expenses are spread out, like an ongoing renovation.
Home equity loan
A home equity loan gives you a lump sum upfront, which you repay over a set term, usually with a fixed interest rate and predictable monthly payments. Terms often range from 5 to 30 years.
This option tends to be better for one-time, known expenses, like renovating a single room or consolidating a specific amount of debt. If you like knowing exactly what your monthly payment will be, the fixed rate may bring you some peace of mind.
Pros and cons of a second mortgage
Like most money decisions, a second mortgage has benefits and drawbacks worth weighing before you commit.
Pros
- Access to a sizable amount of cash: Depending on your available equity, you may qualify to borrow more than you could with other loans.
- Lower interest rates: As a secured loan, a second mortgage often offers lower rates than credit cards and personal loans.
- Flexible spending: You can use the funds for nearly any legal purpose, from home projects to debt consolidation.
Cons
- An extra monthly payment: Adding a second mortgage means another payment in your budget every month.
- Your home is on the line: Because your home is collateral, falling behind on payments could risk losing it.
- Closing costs and fees: These typically range from 2% to 5% of the loan amount and may include origination, appraisal and title fees.
Second mortgage vs. refinance
These two options sound similar but work differently. A second mortgage adds a new loan on top of your existing one. A refinance, on the other hand, replaces your current mortgage with a brand-new loan.
Each may make sense in different situations. A second mortgage could be a fit if you have a good rate on your first mortgage and just need extra funds. A refinance might be worth a look if you want to change your loan’s rate or term. Here’s a quick side-by-side:
| Feature | Second mortgage | Refinance |
|---|---|---|
Structure | Adds a new loan on top of your current mortgage | Replaces your current mortgage with a new one |
Monthly payments | 2 separate payments | 1 payment |
Best for | Keeping your existing mortgage rate while accessing cash | Changing your rate or term, or pulling cash with a cash-out option |
How to apply for a second mortgage
Don’t worry, getting a first mortgage is usually more complicated than getting a second one. Since you’ve already found the home and are in the process of paying it off, there’s a little less due diligence (and fewer upfront costs) involved. Here are the general steps:
- Check your equity. Figure out how much equity you have by subtracting what you owe from your home’s current value. You can use our HELOC Calculator to get an idea of how much you could potentially borrow.
- Review your credit and debt-to-income ratio. Many lenders look for a credit history in good standing and a debt-to-income ratio of 43% or less. Check your credit report to make sure there are no errors that could bring your score down.
- Gather your documents. Expect to provide proof of income, like recent pay stubs, plus proof of homeowners insurance.
- Compare your options. Review rates, terms and fees from a few different lenders.
- Submit an application. Once you’ve found a fit, apply with your chosen lender and move through their review process.
Taking it one step at a time helps to make the whole process feel a lot less daunting. A qualified lender will walk you through the entire process from start to finish.
Is a second mortgage right for me?
A second mortgage may be a helpful tool when you need to access the equity you’ve built, whether that’s for a renovation, a big expense or simplifying your debt. If you’ve built up solid equity, have a steady income and want to access cash without selling your home, a second mortgage could be a good option. The key is borrowing within your means and feeling confident you can keep up with both payments, since your home is part of the deal.
Take time to review your equity, budget and goals before moving forward. A little homework now may save you stress later and help you choose the path that fits your life best.
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