Essential Takeaways
- A second mortgage is a loan secured by your home, taken out while your initial, or first, mortgage is still being repaid. Just like the first, this secondary mortgage uses your property as collateral.
- Two common forms of second mortgages include a home equity loan and a home equity line of credit (HELOC).
- Typically, second mortgages carry higher interest rates than primary mortgages, yet they frequently offer more economical rates than credit cards or personal loans.
- To qualify for a second mortgage, you must have built a specific amount of equity (your outright ownership stake) in your home, maintain a minimum equity level within the property, and possess a robust credit score.
With property values consistently appreciating over the past 21 months, home values are approaching record peaks. This trend is favorable if you are already a homeowner: The average homeowner holding a mortgage commanded $303,000 in equity by the close of 2024, according to property information and data analyst Cotality.
Should they require immediate cash, homeowners can access their equity to obtain ready funds by securing a second mortgage. This process bears resemblances to the primary mortgage — the loan used to acquire the home — but comes with several crucial distinctions.
Before you extract equity from your home, it’s vital to grasp the mechanics of second mortgages and determine if such an option aligns with your financial circumstances.
What Exactly Is a Second Mortgage?
Most people primarily associate mortgages with loans for purchasing a home. However, once you become a homeowner, your borrowing capabilities can extend further. A second mortgage is precisely what its name implies: another loan that uses your home as security.
Your initial mortgage is termed a first or primary mortgage — not only due to its chronological precedence but also because the original mortgage lender holds the primary claim on your home if you default on payments. Any subsequent loan against the property is known as a subordinate mortgage or a subordinate lien. As its designation suggests, this second mortgage is junior to the first in terms of creditor or lender reimbursement — these lenders are second in line to receive payment if your home faces foreclosure or you declare bankruptcy.
When you obtain a second mortgage, you are borrowing against the equity you’ve accumulated in your home. Equity signifies the portion of the home you own outright, in contrast to the outstanding balance; in essence, it’s the difference between your home’s current market value and the remaining balance on your first mortgage.
How Does a Second Mortgage Operate?
A second mortgage functions quite similarly to a first mortgage, at least in its initial phases.
To secure a second mortgage, you typically follow the same procedures as when you qualified for your primary mortgage. This process involves submitting an application to a lender and furnishing documentation regarding your income, debts, and assets. You might also be required to obtain an appraisal to verify your home’s current market value and to cover closing costs (though some lenders may absorb these). Finally, you will need to sign extensive paperwork outlining the lender’s recourse if you fail to adhere to your repayment terms.
While qualifications for second mortgages can vary, many lenders prefer that you possess at least 15 percent to 20 percent equity in your home. You can generally borrow up to 85 percent of your home’s value, minus your existing mortgage debt. For instance, if you own a home valued at $300,000 with a $200,000 remaining balance on your first mortgage, you might be able to borrow as much as $55,000 through a second mortgage: ($300,000 x 0.85) – $200,000.
Learn more: How much home equity can you borrow?
Requirements for Applying for a Second Mortgage
To apply for a second mortgage, you must fulfill the following criteria:
- Own at least 15% to 20% of the home outright.
- Have a remaining balance on your current mortgage that constitutes less than 80% to 85% of the home’s value.
- Possess a credit score of at least 620 (a higher score is strongly recommended for access to the most competitive rates).
Is It Possible to Obtain a Second Mortgage with Poor Credit?
Qualifying for a second mortgage when you have poor credit presents a considerable challenge, particularly since lenders set a high bar for these inherently riskier loans from the outset: Many anticipate your FICO score to be at least “good” (670) or within the higher end of “fair” (640-669).
Nevertheless, loan approval remains a possibility, especially if you hold a substantial equity stake in your home. To enhance your prospects, consider approaching your primary mortgage lender first (assuming they offer second mortgages). Another viable option is to secure a co-signer with a robust credit profile, which can significantly improve your attractiveness as an applicant.
If you do receive approval, anticipate higher interest rates and more stringent terms — this is often the cost associated with a less-than-stellar credit history.
Learn more: How to get a home equity loan with bad credit.
What Are the Advantages and Disadvantages of Obtaining a Second Mortgage?
Second mortgages can prove beneficial in various scenarios, but they also come with drawbacks that merit consideration.
Advantages
- Access Your Equity: For most Americans, their home represents one of their most valuable assets. A second mortgage provides a mechanism to transform that (typically) illiquid asset into usable cash. In essence, you are self-funding.
- Favorable Interest Rates: While higher than a purchase mortgage, a second mortgage offers some of the lowest available interest rates — more competitive than personal loans and credit cards.
- Diverse Withdrawal Options: Depending on the specific loan vehicle, you can choose to receive funds as a single lump sum (a home equity loan) or access them in stages (a home equity line of credit).
- Potential Tax Benefits: If the funds are utilized for home-related improvements or repairs, the interest paid on a second mortgage may be tax-deductible.
Disadvantages
- Protracted, Costly Application Process: Applying for a second mortgage is quite similar to applying for the first. Approval can take a considerable amount of time, and you will also incur closing costs.
- Limitations on Loan Size: The amount you can borrow is constrained by how much of your home you own outright and your existing mortgage balance.
- An Additional Monthly Payment: Acquiring a second mortgage means introducing another monthly financial obligation into your budget.
- Home at Risk: Borrowing against your home implies putting it on the line; if you are unable to make payments, you risk losing your property.
Types of Second Mortgages
Borrowers seeking to obtain second mortgages can select between two fundamental types: home equity loans or home equity lines of credit.
Home Equity Loan
A home equity loan functions very much like a first mortgage. You receive the entire sum of money upfront and repay it over time with interest through fixed monthly payments. These loans are ideal for situations where you require a single lump sum of cash, such as settling a significant debt or financing a singular, one-time expense like a kitchen renovation or the installation of a new swimming pool.
Before applying, conduct some research into prevailing home equity loan rates. Typically, these rates are a few percentage points higher than standard mortgage rates. Bankrate’s home equity loan calculator can assist you in determining if such a loan is suitable for your situation and how much capital you could potentially access.
Home Equity Line of Credit (HELOC)
A HELOC is a flexible line of credit, akin to a substantial credit card. Once established, you can draw upon it over several years, as frequently as desired and in the amounts you choose. Interest is charged only on the funds you actually withdraw. You have the flexibility to repay borrowed sums and then borrow again.
HELOCs can be an excellent option if you are uncertain of the precise amount of money you’ll need or if your financial requirements will span an extended period. Examples might include funding college tuition incrementally or embarking on a major remodeling project — such as a home addition — that will span many months and involve staged payments to contractors.
HELOC interest rates typically run a few percentage points higher than primary mortgage rates and marginally above home equity loan rates. However, unlike the other two, HELOC rates are usually variable. This implies that they can fluctuate, rising and falling in tandem with general interest rate movements. Bankrate’s HELOC payoff calculator can help you determine if this option aligns with your financial strategy.
Home Equity Loan Versus HELOC
A home equity loan is likely a simpler, more straightforward proposition if you require a five-figure lump sum for clearly defined or finite expenses. Conversely, a HELOC might be the more advantageous choice when you have ongoing financial needs, such as recurring tuition payments, or as an emergency fund.
What Is the Difference Between a Second Mortgage and a Refinance?
Refinancing your mortgage is quite distinct from obtaining a second mortgage.
When you refinance, you are replacing your original mortgage with an entirely new loan featuring a new rate and a new term. When you opt for a second mortgage, you retain that first mortgage (a wise decision if you have an attractive rate on that outstanding balance) while adding an additional loan, resulting in two separate monthly payments.
Another crucial difference lies in timing: Refinancing generally takes as long as securing your first mortgage — expect 30 to 60 days to close, depending on the lender. If you choose a second mortgage, particularly a HELOC, you may be able to access the funds significantly more quickly.
When a Cash-Out Refinance Makes Sense
There exists a specific type of refinancing that also permits you to tap into your home equity: a cash-out refinance.
With a cash-out refi, you take out a new mortgage with a larger principal balance than your current mortgage, pocketing the difference in cash. This additional amount is determined by the value of your home equity. Naturally, this action leaves you with a larger loan to repay, and consequently, higher (usually fixed) monthly payments.
Refinancing can be a suitable choice if, in addition to obtaining cash, you wish to adjust the repayment term of your existing mortgage or can secure a more favorable interest rate on the new loan. Moreover, you gain the convenience of a single monthly payment, rather than two separate ones (as would be the case with a second mortgage).
When a Home Equity Loan or HELOC Makes Sense
A home equity loan or HELOC would be the superior option if you prefer to retain your current mortgage’s exceptionally low rate, or if you are uncertain about the precise duration or amount of money you will need. However, these options function optimally if you possess a substantial portion of your home free and clear, as your outstanding mortgage balance will directly influence the size of any additional loan you can secure. If you still owe a considerable amount, a refinance might, after all, prove to be the more advantageous scenario.
Final Considerations on Second Mortgages
The prospect of a second mortgage might seem formidable — it represents another lien on your primary residence. Nevertheless, it can serve as a valuable instrument within your financial toolkit. If you have successfully paid down a significant portion of the principal on your primary mortgage and possess excellent credit, a second mortgage can enable you to access capital at a competitive rate to pursue other life objectives, such as enhancing your home, funding a business venture, or contributing to a child’s college tuition.
While appealing, embarking on a second mortgage should be approached with the same degree of meticulous care and consideration that you applied to your first mortgage. Can you genuinely afford the additional payments? Are you absolutely confident in your repayment strategy? Remember, you will be taking on more debt while simultaneously placing your home at risk, meaning any missteps could lead to severe consequences.