What Is a Second Mortgage? How Do They Work?

Written by Kim PinnelliUpdated: 28th Dec 2021
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You invest a lot of money into your home, but sometimes you need to tap into it. That’s what a mortgage is for – it helps you tap into the equity you’ve built into your home.

If you don’t want to touch your first mortgage, you may want a second mortgage, so you keep your first mortgage’s rate.

A second mortgage is a great way to tap into your home’s equity, putting the money to good use. But how do they work, and are they safe?

Find out in this guide.

What Is a Second Mortgage?

A second mortgage is a loan separate from the first mortgage on a home. It’s a second lien on the property on the portion of the home you’ve already paid off or the money you invested as a down payment.

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How Does a Second Mortgage Work?

You can take out a second mortgage on your home’s equity. Equity is the difference between a home’s value and the outstanding balance on your first mortgage.

A second mortgage taps into that equity, giving you the cash in hand and requiring a monthly payment that consists of interest and principal to pay the loan back.

You can borrow a home equity loan (fixed second mortgage) or a home equity line of credit that works like a credit card using your home as collateral.

Second Mortgage Example Explained

Here’s a quick example of a second mortgage.

Joe bought a home for $300,000. He put 20% down on the home, which was $60,000. Right when he bought the home, he had $60,000 in equity. Joe has had the loan for 10 years and now owes $175,000, but the house is worth $350,000.

Joe wants to renovate his home and needs money to do it.

Since most lenders allow you to tap into up to 80% of the home’s value, Joe can borrow up to $280,000, but he has $175,000 outstanding on his first mortgage, leaving him with $105,000 to take out in a second mortgage.

Joe has great credit and minimal debts, so he has no problem getting a second mortgage that gives him the $105,000 in hand to do his home renovations.

Joe then has a second mortgage that he pays principal and interest on in addition to his first mortgage.

Types of Second Mortgages

Home Equity Line of Credit (“HELOC”)

A home equity line of credit is like a credit card on your home. The lender gives you a line of credit equal to the amount you qualify for (usually up to 80% of the home’s value minus your first mortgage).

You borrow the full amount, but you don’t have to make principal and interest payments on it until you use the funds.

The money sits in a checking account, and until you withdraw it, you don’t owe any payments.

As soon as you withdraw money, though, you pay interest on it, but you’re free to make principal payments too – just like a credit card.

You can reuse the funds for 10 years. After the first 10 years, the draw period ends, and you enter the repayment period, making principal and interest payments for the remaining 20 years. The interest rate on a HELOC is variable, which means it can change monthly.

Home Equity Loan

A home equity loan is a fixed second mortgage. You borrow a lump sum and receive it all at once. You make principal and interest payments on the full amount, usually for 15 to 20 years.

Unlike the HELOC, you can’t reuse the funds – you receive them all at once, and that’s it.

Home equity loans have fixed interest rates, so you don’t have to worry about the rate adjusting.

Pros and Cons of a Second Mortgage

Pros:

  • You can borrow large sums of money at attractive interest rates since you use your home as collateral
  • Most lenders allow you to borrow between 80% – 90% of the home’s value, which is much higher than most other loans allow
  • You can use the funds however you want

Cons:

  • A second mortgage is another lien on your property, putting your home at risk if you can’t make your payments
  • The rates on second mortgages are usually higher than on first mortgages

What Are the Requirements for a Second Mortgage?

To get a second mortgage, you need a few things:

  • Equity in your home (usually 20% or more)
  • Decent credit
  • Stable income
  • Low debts
  • Proof you can afford another loan payment

Second Mortgage Rates: Are they Higher or Lower?

Second mortgage rates are typically higher than first mortgage loans because they are riskier.

First mortgage lenders get paid first if you foreclose on the home, and oftentimes there isn’t enough money left for the second mortgage lender to get paid.

Second mortgage companies charge higher rates to make up for the risk.

Second Mortgage Costs

The cost of a second mortgage is usually less than the first mortgage, but the fees are still hefty.

The closing costs on first mortgages are between 3% – 5%, but second mortgages may cost slightly less, but not always.

Some of the costs include:

  • Origination fee 1% – 2% of the loan amount
  • Appraisal fee $300 – $500
  • Title search and title work $1,000 or less
  • Underwriting and processing $1,000 or less

Reasons to Get a Second Mortgage

Homeowners take out second mortgages for many reasons. Usually, it’s because they need cash in hand, but sometimes they need it for an emergency fund or even as a down payment on another home.

Here are the most common reasons to get a second mortgage:

  • Cover the cost of the down payment when you buy a home; instead of putting down 20%, you put down 10% and borrow the other 10% in a second mortgage
  • Consolidate debt
  • Make home improvements
  • Cover medical debt
  • Pay for college
  • Supplement retirement income

How to Get a Second Mortgage (Step-by-Step)

#1. Get pre-approved

Get pre-approved by several lenders. Each lender must give you a Loan Estimate, which details the loan costs, including the interest rate, fees, and total costs. Compare the loans side-by-side to choose the right lender.

#2. Choose the lender and provide your documentation

Your lender will require some or all of the following:

  • Proof of your address
  • Proof of employment
  • Income documentation
  • Asset documentation
  • Information on your liabilities

#3. Work with the lender during the underwriting

The lender will underwrite your loan. During the process, they may need more documentation or need questions answered. The faster you provide the necessary documentation, the faster you can close on your loan.

#4. Get the appraisal

Most lenders require an appraisal. Sometimes for a second mortgage, they allow a drive-by appraisal, so the appraiser doesn’t have to come inside, but not always.

Find out the type of appraisal so you can make yourself available.

#5. Wait for the clear to close

The lender will tie up any loose ends, including a title search, to ensure there aren’t any other liens on your property. Once all conditions are cleared, the lender will close on your loan.

#6. Get your cash

When you close on the loan, you’ll receive your cash either as a check or wired unless you borrowed a HELOC. If you did, you’ll receive a checkbook and debit card to access the funds.

#7. Make your 2nd mortgage payments

You’ll make your second mortgage payments just like you make your first payments. Most lenders allow you to set up an online account to make your payments.

Second Mortgage vs. Mortgage Refinance: What Is the Difference?

A second mortgage leaves your first mortgage alone. You keep the same balance, interest rates and make the payments to the same lender. Your second mortgage is separate.

When refinancing your mortgage, you pay off the original first loan with a new loan. The new loan may be for the same amount or more, depending on the reason for the refinance.

The new loan takes first lien position, but a second mortgage always takes the second lien position.

Second Mortgages FAQs

Can You Get a Second Mortgage to Buy Another House?

You can use the equity in your home however you want. If you want to take out a second mortgage to use the cash to buy another house, you can.

It’s often a great way to leverage your investment and make more money by buying a second house using your first home’s equity.

Can You Refinance a Second Mortgage?

You can refinance a second mortgage just like you can refinance a first mortgage. Since refinancing costs money, make sure it makes financial sense to refinance.

Are Second Mortgage Rates Higher than First Mortgage Rates?

HELOC rates are usually pretty low, but second mortgage rates are higher. Sometimes they are higher than first mortgage rates, and sometimes they aren’t.

It depends on your qualifying factors. The higher your credit score is and the lower your debt ratio, the better your chances of securing low rates.

What Is a Silent Second Mortgage?

A silent second mortgage is a ‘gift’ from a charity or government entity. It’s like a down payment gift that you don’t have to pay back if you fulfill the terms of the agreement.

For example, if you must live in the home for 5 years and then the agency will forgive your second loan, you won’t have to repay it if you live there for 5 years.

If you move early, though, voiding the agreement, you may have to pay back a prorated amount of the silent second mortgage.

Is It Better to Refinance a Mortgage or Get a Home Equity Loan?

If you are happy with the interest rate on your first mortgage or you’ve worked hard to pay down your first mortgage, you may not want to refinance it. In this case, a home equity loan makes more sense.

Sometimes, though, you can get a better rate and terms with a cash-out refinance than you had on your first mortgage. It depends on rates when you take out your first mortgage and apply for the second mortgage.

Bottom Line: What Is a Second Mortgage?

A second mortgage can help you tap into your home’s equity and put the money to good use. Some people don’t like to leave equity in their home. They’d rather use it to invest or pay for expenses in other areas of their life.

Before you take out a second mortgage, make sure you know the terms, costs and that you can afford the payment so you don’t put your house at risk of foreclosure.

Kim Pinnelli
Kim Pinnelli

Kim Pinnelli is a Senior Writer, Editor, & Product Analyst with a Bachelor’s Degree in Finance from the University of Illinois at Chicago. She has been a professional financial writer for over 15 years, and has appeared in a myriad of industry leading financial media outlets. Leveraging her personal experience, Kim is committed to helping people take charge of their personal finances and make simple financial decisions.