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Everything You Need To Know About Second Mortgages

7-minute read

There are plenty of reasons why you might need access to a large amount of money. Maybe you’re thinking about going back to school or need to consolidate a few high credit card balances. Or maybe you want to do some repairs on your home.
 
Why not consider tapping into your home’s equity, which is usually much larger than any cash reserves you have on hand? You may also be able to use a second mortgage to take care of your expenses.
 
We’ll cover what you need to know about second mortgages and how they work. We’ll also lay out some scenarios where it might make sense to take out a second mortgage.

What Is A Second Mortgage?

A second mortgage is a lien taken out against a property that already has a loan on it. A lien is a right to possess and seize property under specific circumstances. In other words, your lender has the right to take control of your home if you default on your loan. When you take out a second mortgage, a lien is taken out against the portion of your home that you’ve paid off.
 
Unlike other types of loans, such as auto loans or student loans, you can use the money from your second mortgage for almost anything. Second mortgage lenders also offer interest rates that are much lower than credit cards. This makes them an appealing choice for paying off credit card debt.

How Does Home Equity Work?

Before we talk more in-depth about what a second mortgage is and who they’re for, let’s learn a little bit more about home equity. Your home equity determines how much money you can get when you take out a second mortgage.
 
Unless your mortgage loan has a balance of $0, you don’t technically own your home. Your mortgage lender owns a percentage of your home until you finish paying back the loan. As you pay off your principal loan balance over time, you own more of your home. The portion of the loan that you have paid off is called equity.
 
Calculating your home equity is relatively easy. Subtract the amount that you’ve paid toward the principal balance of your home from the total amount you borrowed. For example, if you bought a home worth $200,000 and you’ve paid off $60,000 worth of equity including your down payment, you have $60,000 worth of equity in your home. The interest you pay doesn’t count toward your home equity.
 
Your home equity can also increase in other ways. If you’re in a particularly strong real estate market or you make improvements on your home, the value of your home goes up. This increases your equity without extra payments. On the other hand, if the value of your home goes down and you enter a buyer’s market, you may lose equity.
 
Having trouble figuring out how much equity you have in your home? Contact your lender or use the Rocket Mortgage calculator to find out.

Second Mortgage Vs. Refinance: What’s The Difference?

A second mortgage is different than a mortgage refinance. When you take out a second mortgage, you add an entirely new mortgage payment to your list of monthly obligations. You must pay your original mortgage as well as another payment to the second lender. On the other hand, when you refinance, you pay off your original loan and replace it with a new set of loan terms from your original lender. You only make one payment a month with a refinance.
 
When your lender refinances a mortgage, they know that they already have a lien on the property, which they can take as collateral if you don’t pay your loan. Lenders who take a second mortgage don’t have the same guarantee. In the event of a foreclosure, your second lender only gets paid after the first lender receives their money back. This means if you fall far behind on your original loan payments, the second lender might not get anything at all. You may have to pay a higher interest rate on a second mortgage than a refinance.
 
This leads many homeowners to choose a cash-out refinance over a second mortgage. Cash-out refinances give you a single lump sum of equity from your original lender in exchange for a new, higher principal.

Here’s an example of a cash-out refinance: Let’s say you’ve paid off $50,000 of the home that you bought for $200,000. In other words, you still owe $150,000 on your home. Let’s also say that you want to make $20,000 worth of renovations.

 
You’ll add what you’ve taken out onto your new mortgage principal. This means your new mortgage would be worth $170,000 – the original $150,000 you owed on the home plus the $20,000 you need for renovations. Your lender will then give you the $20,000 in cash a few days after you close.

Types of Second Mortgages

There are two major types of second mortgages you can choose from: a home equity loan or a home equity line of credit (HELOC).

Home Equity Loan

A home equity loan is like a cash-out refinance in that it allows you to take a lump-sum payment from your equity. When you take out a home equity loan, your second mortgage provider gives you a percentage of your equity in cash. In exchange, the lender gets a second lien on your property. You pay the loan back in monthly installments with interest, just like your original mortgage. Most home equity loan terms range from 5 – 30 years, which means that you pay them back over that set number of years.  

Home Equity Line of Credit

Home equity lines of credit (HELOCs) don’t give you money in a single lump sum. Instead, HELOCs work more like a credit card. Your lender approves you for a line of credit based on the amount of equity you have in your home. Then, you can borrow against the credit the lender extends to you. You may receive special checks or a credit card to make purchases. Like a credit card, HELOCs use a revolving balance. This means that you can use the money on your credit line multiple times as long as you pay it back. For example, if your lender approves you for a $10,000 HELOC, you spend $5,000 and pay it back, then you can use the full $10,000 again in the future.
 
HELOCs are only valid for a predetermined period of time called a “draw period.” You must make minimum monthly payments during your draw period as you do on a credit card. Once your draw period ends, you must repay the entire balance left on your loan. Your lender might require you to pay in a single lump sum or make repayments over a period of time. If you cannot repay what you borrowed at the end of the repayment period, your lender can seize your home.

Things To Consider When Getting A Second Mortgage

Like any other type of loan, there are both benefits and drawbacks to taking out a second mortgage. 

Benefits

  • High loan amounts. Some lenders allow you to take up to 90% of your home’s equity in a second mortgage. This means that you can borrow more money with a second mortgage than with other types of loans, especially if you’ve been making payments on your loan for a long time.
  • Lower interest rates than credit cards. Second mortgages are considered secured debt, which means that they have collateral behind them (your home). Lenders offer lower rates on second mortgages than credit cards because there’s less of a risk that the lender will lose money.
  • No limits on fund usage. There are no laws or rules that dictate how you can use the money you take from your second mortgage. From planning a wedding to paying off college debt, the sky’s the limit.

Considerations

  • Second mortgages have higher interest rates. Second mortgages often have higher interest rates than refinances. This is because lenders don’t have as much collateral in your home as your primary lender.
  • Second mortgages might put pressure on your budget. When you take out a second mortgage, you agree to make two monthly mortgage payments: One to your original lender and another to your secondary lender. This can put a strain on your household finances, especially if you’re already living paycheck to paycheck.

Should I Get a Second Mortgage?

Second mortgages aren’t for everyone, but they can make perfect sense in the right scenario. Here are some of the situations in which it makes sense to take out a second mortgage.

You Need to Pay Off Credit Card Debt

Second mortgages have lower interest rates than credit cards. If you have many credit card balances spread across multiple accounts, a second mortgage can help you consolidate your debt.

You Need Help Covering Revolving Expenses

Do you need revolving credit? HELOCs can give you access to revolving credit as long as you keep up with your payments. This can be a more manageable option if you’re covering a home repair bill or tuition on a monthly basis.

You Cannot Get a Cash-Out Refinance

Cash-out refinances usually have lower interest rates than second mortgages. But if your lender rejects you for a refinance, you may still be able to get a second mortgage. Consider all of your options before you get a second mortgage.

Summary

Second mortgages take out a lien on the amount of your home that you own, which is called equity. When you take out a second mortgage, your lender may give you a single lump-sum home equity loan or a revolving line of home equity credit (called a HELOC). If you cannot pay back your second mortgage, your lender can take your home.
 
Second mortgages are different than refinances because they add another monthly payment to your budget instead of changing the terms of your current loan. Second mortgages are usually more difficult to get than cash-out refinances because the lender has less of a claim to the property than the primary lender. Many people use second mortgages to pay for large, one-time expenses like consolidating credit card debt or covering college tuition.
 
It’s a good idea to consider all of your options and be sure you can keep up with payments before you choose a second mortgage. Reach out to the Home Loan Experts at Rocket Mortgage for more guidance.

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