A Comprehensive Guide to Second Mortgages Loan

What Is a Second Mortgage?

 

 

Understanding the Mechanics of a Second Mortgage

 

Securing a second mortgage implies taking on an additional loan that is collateralized by your home, even if you typically haven’t fully repaid the initial one.1 While “second mortgage” is an industry term, it’s worth noting you can still obtain such a loan even if your home is owned outright.2 Unlike a refinance, a second mortgage exists as a completely distinct financial product and does not alter the terms of your primary mortgage.3

 

You will be responsible for making concurrent monthly payments on both your second mortgage and, if applicable, your primary mortgage.4 However, in an unfortunate scenario such as foreclosure or bankruptcy, the lender of your original mortgage would receive repayment before any funds are allocated to the lender holding the second mortgage.5

 

 

Types of Second Mortgages

 

You will primarily encounter two main categories of second mortgages: home equity loans and Home Equity Lines of Credit (HELOCs).6

 

Home Equity Loans

A home equity loan represents a form of second mortgage that provides you with a single lump sum of money.7 This amount is then repaid at a fixed interest rate over a predetermined period, often extending up to 30 years. This type of loan can be ideal if your borrowing needs are precisely defined and you prefer consistent, predictable monthly payments.

HELOCs

A Home Equity Line of Credit, or HELOC, operates as an open line of credit from which you can draw funds as needed, up to a pre-established limit.8 Unless you select a lender offering a fixed-rate option, your interest rate will automatically be variable, meaning it will fluctuate in response to market conditions.

Typically, you have a period of 10 years to draw from this line (referred to as the “draw period”), during which you are generally only obligated to pay interest.9 Following the draw period, you transition into the repayment phase, where further withdrawals are prohibited, and you must begin paying both principal and interest.10

 

This kind of loan may be a suitable choice if you’re uncertain of the exact amount you’ll need to borrow (for instance, if you’re undertaking a series of renovation projects with a flexible budget). You will also need to be comfortable with payments that will change over time as interest rates shift, unless you plan to refinance your primary mortgage to pay off the HELOC.

» MORE: Explore NerdWallet’s picks for the best home equity lenders.

 

How to Qualify for a Second Mortgage

 

While precise requirements vary among lenders, there are several standard minimums you’ll need to satisfy to qualify with the broadest range of financial institutions.

Home Equity

Firstly, you’ll need sufficient home equity. To estimate your home equity, simply subtract your current mortgage balance from your home’s present value — this represents the portion of your home you genuinely own outright.11 Most lenders will permit you to borrow a maximum of 85% of your home’s value, minus your outstanding debt (though some may have higher or lower limits).12

Credit Score

A credit score of at least 640 is the customary minimum for a second mortgage.13 Lenders may request a higher score, particularly if you are seeking to borrow a substantial amount. A score exceeding 700 can also help you secure a more favorable interest rate.

Other Debts Relative to Your Income

Just as with a primary mortgage, your debt-to-income ratio (DTI) — the proportion of your monthly earnings dedicated to monthly debt payments — should ideally be less than 43% for a second mortgage.14 Lenders, however, retain the discretion to require a lower DTI.

» MORE: Home equity loan and HELOC requirements.

 

Second Mortgages Versus Refinancing

 

Beyond obtaining a home equity loan or HELOC, there’s a third method to access your home’s equity: a cash-out refinance. This involves refinancing your primary mortgage into a larger loan than your current outstanding balance, allowing you to receive the difference in cash.

Cash-out refinances typically feature a fixed interest rate and commonly have terms extending up to 30 years.15

 

Several factors might lead you to prefer a cash-out refinance over a second mortgage. For one, if you can secure a lower interest rate than your current payment, a cash-out refinance would both offer a better rate and provide you with available cash. Another reason to opt for a cash-out refinance is a simple preference for maintaining a single mortgage rather than managing multiple ones.

It is also quite common for borrowers with an existing second mortgage to pursue a cash-out refinance to consolidate their debt into one loan with a fixed interest rate.16

 

» MORE: Explore NerdWallet’s picks for the best cash-out refinance lenders.

 

Advantages and Disadvantages of Second Mortgages

 

A second mortgage won’t be your sole financing option, and carefully weighing its pros and cons can help you determine if it’s the right fit for your needs.

 

Advantages

 

  • Interest rates are typically lower than those found with personal loans, credit cards, or other forms of unsecured debt.17

     

  • Your primary mortgage remains unaltered.
  • You benefit from a lengthy repayment timeline (often up to 30 years).

 

Disadvantages

 

  • You risk losing your home to foreclosure if you fail to maintain monthly payments.
  • If you choose a variable-rate HELOC, the interest rate could potentially rise to a level you cannot comfortably afford.
  • Interest rates are generally higher than those on your primary mortgage.18

     

» MORE: HELOC vs. home equity loan pros and cons.

 

How to Obtain a Second Mortgage

 

The process of obtaining a second mortgage is quite similar to securing a primary mortgage, though there are a few distinctions.19 You won’t typically engage a real estate agent, and a home inspection won’t be necessary. You will, however, require a home appraisal, as the current market value of your home plays a significant role in determining your borrowing capacity.

 

Here’s an overview of the steps involved in getting a second mortgage:

  1. Calculate your approximate home equity and determine the amount you wish to borrow.
  2. Gather documentation pertaining to your current income and debts.
  3. Compare various second mortgage lenders.
  4. Submit your application for the second mortgage.
  5. Review the disclosure documents carefully. Verify that the terms align with your expectations and that you can comfortably afford the second mortgage payments.
  6. Provide any additional documentation requested for underwriting.
  7. Proceed to close on the second mortgage.