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How Does A Second Mortgage Work 

 April 9, 2021

By Scott Teesdale  

minutes read time

If you’re in need of a large amount of money then a second mortgage might be the best way to get it. The equity in your home is the total value of your home after the debt (i.e., the mortgage) is fully paid off. Thus, as you make your monthly mortgage payments, the equity in your home increases. You can take out a second mortgage by tapping into your home’s value (i.e., the equity). There are two common ways to do this: a home equity loan (HEL) or a home equity line of credit (HELOC).

What is a second mortgage?

A second mortgage is simply a different type of mortgage than your original mortgage. Assuming you already have a mortgage and want to take advantage of the equity built up in your home by withdrawing cash against it, you would apply for a “second mortgage.” In a nutshell, a second mortgage uses your home as collateral when to withdraw money from the property’s value. Said another way, a second mortgage is your way of pulling your money back out of a home.

Just like a primary mortgage, with a secondary loan, you’re telling the lender that if you can’t make the payments then you may lose your home. That’s why it’s important to make sure you brush up on your real estate terminology and definitions before you dive into a second mortgage.

To qualify for a second mortgage, you’ll need to first have the right credit score. If you don’t have a credit score of at least 620 then getting a second mortgage approval will be extremely difficult, if not outright impossible.

Should you get a second mortgage or refinance your home?

Depending on your situation, it might be better to refinance your home compared to getting a second mortgage. When I decided to take a second mortgage out of my home over refinancing, these were what I considered first.

Expenses

My wife and I were having a baby and neither of our families could help us financially. Our expenses started to add up. Reaching into my home to get much-needed money was one of the best options in our situation. My first mortgage was used to build equity and accumulate that money and my second mortgage was used to reach into that equity and access it.

Debt

I accumulated a bit of debt that I absolutely needed to pay down. This was my reasoning for getting a second mortgage in the first place. It wasn’t a recurring expense rather than a large sum of money that needed to be paid.  A second mortgage is perfect for using your home to pay down debt. Debt is one major factor to consider when choosing a mortgage.

Low on options

I was very low on options. A second mortgage was my last-ditch effort because I needed money quickly and don’t have any other assets that I felt I could liquidate or sell at the time. I bet against my house which has both its pros and cons that I’ll explain later in this article.

I considered refinancing my home, but at the time it didn’t matter if I wanted to pay lower interest rates back on the money. I was confident about my credit scores and knew that it would lead to a better outcome if I did a second mortgage and paid slightly higher interest than I would if I did refinance.

Different types of second mortgages

Home equity loans (HEL)

A home equity loan is one route to accessing the money in your home. It’s money that is secured by your home and you can repay the loan the same way you did your original mortgage. Income, market value, and credit also can go into how much you can actually borrow. It’s important to understand how mortgages work because there is another way to tap into your home’s equity, which I’ll discuss next.

Your mortgage lender will take out a certain percentage of value from your home’s equity to pay you for your second mortgage. To pay this money back, typically you’ll have to pay a fixed monthly payment for a certain number of years that can range between 5 to 30. This part is very similar to paying off your primary mortgage loan. It will most likely be required to be paid off at a fixed interest rate. This fixed rate will determine the repayment period.

One of the best parts about taking out a second mortgage is the fact that you get paid a lump sum of cash. You won’t have to be worried about receiving payments or getting paid at a certain rate.

Even though you can receive a lump sum of money through a home equity loan, and there are both pros and cons to this type of loan.

Pros:

  • Designed for larger lump sums of money so you can take out more value from your home. Sometimes homeowners are able to take out over 80% of their home’s value and receive it in cash. This makes these types of second mortgages really valuable when it comes to home equity.
  • Even though your interest rates can be high, the rates will be lower than the first mortgage payment that you had on your home and lower than any credit card.
  • As long as you can make your payments each month, it might be wise to use a second mortgage for your debt.

Cons:

  • If you get a second mortgage then you might have to worry about comparing the interest rates to the rates of refinancing a home. Refinancing rates will be much lower than the rates you get with a home equity loan.
  • A mortgage payment that comes at a time when you had already paid off your home can be a burden on your financial situation. Mortgage rates and equity in your home won’t matter as much if you aren’t to start making payments

Home equity line of credit (HELOC)

While taking out a home equity loan is one way to access your home’s mortgage and tap into the money that your home’s been growing over the years, HELOC is another way.  HELOC stands for home equity line of credit and there are different rules that you must be aware of if you’re thinking about taking this route.

Home equity lines of credit make second mortgages more attractive to some homeowners because you  only use exactly what you need to use from your second mortgage and not a huge lump sum that you might not actually need.

The major difference between a home equity line of credit (HELOC) and home equity loan (HEL) is how you will receive your money. The way you’re paid by a home equity loan is in installments compared to one lump sum. HELOCs are similar to credit cards in the sense of establishing a credit line and you can borrow against your credit line value numerous times as long as you are able to afford it.  These types of loans revolve around taking against a certain amount of money and then repaying it back and being able to do it multiple times for a predetermined amount of time. If your loan balance is paid off then you don’t have to worry about repaying your mortgage lender.

Pros:

  • This type of the second mortgage is different from other second mortgages because it’s not just used for large amounts of money to be pulled from your home but can be used for smaller amounts as well.
  • Home equity loans are typically used for larger amounts of money that can be taken from the equity of your home. Whereas a HELOC has a draw period where you can withdraw a certain amount of money and you don’t have to use all of it.

Cons:

  • When it comes to the lenders of your HELOC, it can be tricky to make the payments on these types of loans. You will most likely need to make two loan payments to your lenders, one that goes to your original lender and one that goes to the secondary lender of the second mortgage. This can make paying second mortgages difficult because not only are you paying one monthly payment to use a second mortgage but now you’re paying two.
  • Just like any loan, you will have to pay back a HELOC if you decide to use it for your second mortgage and if you had already paid off your home, it can be a burden to pay off your home again.

Finding a lender for your loans

On top of a certain credit score, to be approved for a second mortgage by a lender you’ll also need to actually do the research and find mortgage lenders to figure out how much home mortgage you qualify for. Second mortgage rates can be tricky no matter if you’re looking for a HEL or HELOC.

Shop around for a lender and do some research on a good real estate agent to find out exactly how you can find a lender with your personal interests in mind. Finding a lender who understands your refinance situation because lenders that don’t could put you in a situation that you don’t want to be in with your cash.

If you’re looking for a lender, it’s a good idea to make sure that they meet a few different qualifications before actually using them.

  • Make sure they have your best interests in mind first and that they can get you your designated rates second.  Loans can be tricky and you want to work with someone who has your best interest in mind.
  • Make sure it’s a company that is an LLC all rights reserved so you know it’s legitimate. You don’t want to get scammed.

Interest rate

When it comes to refinancing your home, one of the first questions you might have is about the interest rates. Yes, a second mortgage will have different interest rates than your first but depending on what route you take when acquiring your second mortgage could make this rate vary. Mortgage lenders are smart with the money they loan.

On top of that, personal loans and debt-to-income ratios will come into play when lenders are looking at your application. They won’t let you borrow as much money at a lower interest rate if your financial situation is cluttered with a lot of debt and expenses. This is the same reason why you can’t refinance and have to borrow in the first place.

The bottom line about second mortgages

If you’re considering a second mortgage then it will be in your best interest to first look at your primary mortgage and loan situation. Make sure you’re aware of every homebuyer mortgage hint available to you. You’ll have to decide between a HEL and HELOC.

Not every loan is bad and sometimes you need money and have nowhere else to turn. By building the value of your home and paying installments of your primary mortgage over the years, you’ve solidified a bank account that you can live in and take money from.

If you take anything away from this story, remember the differences between a HELOC and HEL.

HELOC for a second mortgage

A HELOC has a varying interest rate that is designed to be a credit line. You can get a specific amount of money without taking out a lump sum of money. The payments on a HELOC are not usually fixed and can vary.

HEL for a second mortgage

HEL gives the homeowner a lump sum of money fast and must be returned with fixed payments and fixed interest rates.

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How Often Can You Refinance Your Home?

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I use data and technology to help Millennials navigate the ins-and-outs of buying or selling a home in today's market. From appraisals to mortgages to zoning, I cover it all with the goal to teach others. Connect with me on social via the icons above.

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