Getting a Second Mortgage: Definition, How to Get One, Benefits

Homeowners who have enough equity in their homes may be able to take on second mortgages. Getting a second mortgage can be beneficial to someone who might need to use the money to pay off outstanding debts or remodel their home. At the same time, it can also be a risky move. Before you start your application, we’ve got the lowdown on everything you need to know about second mortgages.

If you’re looking for help with your finances in any area, especially one that impacts you long-term, consider working with a financial advisor.

What Is a Second Mortgage?

Homebuyers who can’t pay for their homes up front usually opt to get mortgages. Once a homeowner has made significant progress toward paying off the first mortgage, he or she can try to get approved for a second mortgage. A second mortgage is just an additional home loan that someone can take on to get access to more financing.

Second mortgages come in two different flavors: home equity loans and home equity lines of credit. Both let homeowners borrow against their home equity.

Home equity loans are second mortgages that usually come with fixed interest rates, although some have variable rates. When you take out a home equity loan, you get the entire loan amount at once.

A home equity line of credit (HELOC), on the other hand, works more like a credit card. Instead of getting a lump sum payment, you’re allowed to borrow what you need when you need it, up to your credit limit. HELOCs come with adjustable interest rates (meaning that the interest rate you’re charged will vary). You’ll use a credit card or write a check to get the money from your HELOC and then you’ll make monthly payments to pay off the debt like you would with a credit card.

Unlike first mortgage loans, which typically come with 15-year or 30-year loan terms, home equity loans and HELOCs are normally paid off relatively quickly. While they can have 30-year terms (particularly if they’re fixed-rate home equity loans), these mortgages tend to have repayment periods lasting for five to 15 years.

How to Get a Second Mortgage

Many lenders offer second mortgages, giving you the option to shop around for better rates and terms instead of using your original lender.

Many lenders offer second mortgages, so you can choose a different lender if you don’t want to use the same bank, credit union or online lender that approved you for your first home loan. Comparing lenders is a good idea if you want the best mortgage rates and terms.

Applying for a second mortgage isn’t that different from applying for a primary home loan. You’ll go through an underwriting process and your lender will look at your credit and your financial track record. If your credit score is in good shape and you meet your lender’s requirements, you might qualify for a loan worth as much as 85% of your home equity.

You should note that a second mortgage does not provide immediate funds, as the approval and closing process can take several weeks, making it less suitable for urgent financial needs.

The Benefits of Second Mortgages

What’s great about second mortgage loans is that you can use them to fund a variety of projects. The kind of second mortgage that’s best for you depends on how much money you need and what you plan to use your loan for.

If you need a specific amount of money for a one-time expense – like $6,000 for a family member’s retirement party – it might make more sense to get a home equity loan rather than a HELOC. Home equity loans are also useful for homeowners who need a large amount of financing to consolidate other loans or help their kids pay for college.

But if you’re not exactly sure how long you might need financing or you’d like to borrow different amounts of money from month to month, you’d probably be better off with a HELOC. You can use a HELOC to make payments over time if, for example, you’re working on a small home renovation project or you have to pay for a series of emergencies.

Another advantage of having a second mortgage is the fact that your mortgage interest can be tax-deductible. If you have a home equity loan or a HELOC and use the funds to buy, build or substantially improve your home, you might be able to deduct the interest.

Related Article: All About the Mortgage Interest Deduction

Why Second Mortgages Are Risky

Before taking on a second mortgage, consider that the loan must be repaid and your home is at risk of foreclosure if you fall behind.

Before you take on a second mortgage, it’s important to consider the drawbacks of getting one. Ultimately, you’ll have to pay back the funds you borrow. Since your home acts as your collateral (meaning that it secures your loan), your lender can force you into foreclosure and take your house if you fail to pay off your second mortgage.

Second mortgages are subordinate to primary mortgages, so if you default on your loans, the debt from your first mortgage gets paid off before the second mortgage lender receives anything. For that reason, home equity loans and HELOCs are considered to be riskier for lenders than traditional home loans. Therefore, they typically have higher interest rates.

In addition to the higher mortgage rates, there are additional fees that you’ll owe if you want a second mortgage. Closing costs for second mortgages can be as much as 3% to 6% of your loan balance. If you’re planning to refinance, having a second mortgage can make the whole process trickier to navigate.

Home equity loan payments are generally easier to manage because you can set up your budget knowing what you’ll pay every month for that second home loan. Since the amount you owe for a HELOC will vary, however, you might not be able to pay your bill if it’s significantly more expensive than it previously was. And if you need a second mortgage to pay off existing debt, that extra loan could hurt your credit score and you could be stuck making payments to your lenders for years.

Related Article: The Best Mortgage Refinance Rates

How Lenders Evaluate You for a Second Mortgage

Before approving a second mortgage, lenders want to see that you are financially stable. They start by looking at your credit score. A higher score shows that you have managed debt well in the past, and it can help you qualify for lower interest rates. If your score is low, say below 600, you may still qualify, but the loan will likely cost more.

Next, lenders check your loan-to-value (LTV) ratio. This compares the amount you still owe on your first mortgage to the current value of your home. Most lenders allow you to borrow up to about 80% to 85% of your home’s equity, which means you need to have built up significant equity before applying.

They also look at your debt-to-income (DTI) ratio. This is the percentage of your monthly income that goes toward paying debt, including your first mortgage, car loans, credit cards and other obligations. A lower DTI means you have more room in your budget, which makes you a safer bet for lenders.

Lenders will usually ask for proof of your income and employment. Pay stubs, W-2 forms and tax returns are common documents you’ll need to provide. They may also want to see details about your assets, such as savings accounts or retirement funds, to make sure you can handle the extra loan.

All of these checks give lenders a picture of how much risk they take on by giving you a second mortgage. The stronger your credit, income and equity, the better your chances of approval and the more favorable the terms will be. Preparing these pieces in advance can make the process smoother and may save you money over the life of the loan.

Bottom Line

Getting a second home loan is a serious undertaking, especially because you risk losing your home if you can’t keep up with your mortgage payments. If you’re set on applying for one, it’s best to proceed with caution and think about the problems you could face from taking on additional debt.

That caution is echoed by experts. “When used correctly, a HELOC or home equity loan can be a lifeline for equity-rich homeowners who need cash in relatively short order,” said Tanza Loudenback, CFP®. “It’s best not to take on a second mortgage unless you have a specific reason for needing the funds, the rate is lower than it would be on a credit card or personal loan and you’re certain you can afford the payments.”

Tanza Loudenback, CFP® provided the quote used in this article. Please note that Loudenback is not a participant in SmartAsset AMP, is not an employee of SmartAsset and has been compensated. The opinion voiced in the quote is for general information only and not intended to provide specific advice or recommendations.

Tips for Real Estate Investing

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When buying a second home, instead of just getting a second mortgage on your current home, don’t forget about the property taxes. Many locations of second homes can be in areas where taxes are high to own property. Use a property tax calculator to help you estimate what you might pay before you buy.