What Is a Second Mortgage?
A second mortgage is a type of loan taken out on a property or home that currently has a mortgage loan. A first mortgage is a loan typically used to purchase a home, while a second mortgage is a loan taken out on the equity of the home. As you pay down your mortgage, equity or ownership builds over time. A second mortgage allows you to tap into the home equity and take out a second loan.
A second mortgage is subordinate to the first mortgage. If the borrower defaults on the payments, the original or first mortgage will receive all proceeds from the property’s liquidation until it is paid off. As a result, the interest rate charged for the second mortgage tends to be higher, and the amount borrowed is lower than that of the first mortgage.
How a Second Mortgage Works
When most people purchase a home or property, they take out a home loan from a lending institution that uses the property as collateral. This home loan is called a mortgage, or more specifically, a first mortgage. The borrower must repay the loan in monthly installments made up of a portion of the principal amount and interest payments. Over time, as the homeowner makes good on their monthly payments, the home also tends to appreciate in value.
The difference between the home’s current market value and any remaining mortgage payments is called home equity. A homeowner may decide to borrow against their home equity to fund other projects or expenditures. The loan they take out against their home equity is a second mortgage, as they already have an outstanding first mortgage. The second mortgage is a lump-sum payment made out to the borrower at the beginning of the loan.
Like first mortgages, second mortgages must be repaid over a specified term at a fixed or variable interest rate, depending on the loan agreement signed with the lender. The loan must be paid off first before the borrower can take on another mortgage against their home equity.
Requirements for a Second Mortgage
To qualify for a second mortgage, you will need to meet a few financial requirements. You typically will need a credit score of 620 or higher, a debt-to-income (DTI) ratio of 43% or lower, and a decent amount of equity in your first home. Because you are using the equity in your home for the second mortgage, you will need to have enough to not only take out your second loan but also to be able to keep approximately 20% of your home’s equity in the first mortgage.
Special Considerations
Borrowing Limits
It may be possible to borrow a hefty amount of money with a second mortgage. Second mortgage loans use your home (presumably a significant asset) as collateral, so the more equity you have in a home, the better. Most lenders will allow you to borrow at least up to 80% of your home’s value, and some lenders will let you borrow more.
Approval Time
Like all mortgages, there is a process for obtaining a HELOC or a home equity loan, and the timeline may vary. You will need to apply for an appraisal of your home, and it usually takes the lender’s underwriter a few weeks to review your application. It could be four weeks, or it could be longer, depending on your circumstances.
Second Mortgage Costs
Just like the purchase mortgage, there are costs associated with taking out a second mortgage. These costs include appraisal fees, costs to run a credit check, and origination fees.
Although most second-mortgage lenders state that they don’t charge closing costs, the borrower still must pay closing costs in some way—the cost is included in the total price of taking out a second loan on a home.
Since a lender in a second position takes on more risk than one in the first position, not all lenders offer a second mortgage. Those that do offer them take great steps to ensure that the borrower is good to make payments on the loan. When considering a borrower’s application for a home equity loan, the lender will check whether the property has significant equity in the first mortgage, a high credit score, a stable employment history, and a low debt-to-income ratio.
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