Second mortgage: What it is, how to get one, pros, and cons

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• With a second mortgage, you borrow money depending on how much equity you have in your home.
• A home equity loan and a home equity line of credit are both types of second mortgages.
• Use the money from a second mortgage however you want, but be prepared to pay closing costs.

If you need to access a substantial amount of money — maybe to pay down high-interest debt or to make home repairs — tapping into your home equity may be a good way to go about it.

As your home accumulates value and you pay down your mortgage principal, you gain equity in the home. You can use this equity to get a second mortgage and cover large expenses.

What is a second mortgage?

A second mortgage is a type of loan that lets you tap into the equity of your home. If you've paid off a portion of your first mortgage or your home has gained value, you have the opportunity to put the money you have in your home to good use.

When you get a first mortgage, you use the money to buy a home. A second mortgage gives you cash to cover other expenses. Both mortgages use your home as collateral, so if you fail to make payments, you risk foreclosure to pay off your mortgages.

You'll still keep your first mortgage. You'll get a second mortgage on top of your initial one, and you'll have two mortgage payments each month.

Taking out a second mortgage is one way to access a large sum of money, and you may find you prefer it to taking out a personal loan or using a credit card.

How home equity affects your second mortgage

Home equity is the amount of your home that you own. When you take out a mortgage, you don't own the house outright. The more you pay down your loan, the more of your home you own, financially speaking.

For example, let's say you buy a $200,000 home. You have $20,000 for a down payment, so you take out a $180,000 mortgage. Divide $20,000 by $200,000 to get 0.10 — you have 10% equity in your home from the get-go.

Fast forward a few years, and you've paid off another $40,000 of your mortgage principal. (Payments toward your interest don't help you build equity.) You've now paid $60,000 toward your $200,000 house, so you have 30% equity in your home.

Making payments toward your mortgage is the simplest way to gain equity. Your home may also gain value if the local housing market improves or you make home improvements. Or you could lose equity if the home value drops.

The amount of equity you have affects how much you can borrow with your second mortgage. Rules vary by mortgage lender, but many companies want you to keep at least 20% equity in your home after taking out the second mortgage. So if you have 30% equity in your home, you can borrow the equivalent of 10% of your equity.

Types of second mortgages

There are two types of second mortgages: a home equity loan and HELOC.

Home equity loan

With a home equity loan, you receive cash in one lump sum. Then you pay it back in monthly installments over a predetermined amount of time, like 30 years. It's a similar concept as a regular mortgage, except it provides you with cash.

Home equity line of credit

A HELOC works more like a credit card than like a regular mortgage. The HELOC lender gives you a borrowing limit, and you can borrow from that line of credit as needed. Maybe you take out $5,000 to pay off a credit card, then $10,000 later to remodel your bathroom.

As with a credit card, you'll pay back what you borrow, and you can borrow more later. If your borrowing limit is $20,000 and you borrow $10,000, you have $10,000 left to borrow. But if you pay back the full $10,000, your limit is back to $20,000.

Your lender gives you a "draw period," which is a chunk of time you're allowed to borrow money — usually 10 years or less. At the end of the HELOC draw period, you must repay any balance you haven't paid back yet.

Second mortgage vs. refinance

Getting a second mortgage isn't the same thing as refinancing a home. When you take out a second mortgage, you tack another mortgage onto your initial one. When you refinance, you replace your first mortgage with a brand-new one that has different terms.

With a second mortgage, you make two mortgage payments each month, one toward the first and one toward the second. With a refinanced mortgage, you just make one monthly mortgage payment.

Second mortgage interest rates are usually higher than mortgage refinance rates, because second mortgages are riskier for lenders. If you were to foreclose on your home, the funds would pay off the original mortgage first, then the second. It's possible the second mortgage wouldn't be paid off in full with a foreclosure. When loans are riskier for lenders, they usually charge higher rates.

There is a type of mortgage refinance that's very similar to a home equity loan: a cash-out refinance. With a cash-out refinance, you borrow against the equity you have in the home and receive cash.

The main difference between a second mortgage and a cash-out refinance is that the latter replaces your first mortgage all together. Cash-out refinances usually charge lower rates than home equity loans or HELOCs, but closing costs are more expensive.

How to get a second mortgage

Just as with your first mortgage, you'll need to meet specific requirements to qualify for a second mortgage. Here are the terms you can expect:

• Home equity. You need to have equity in your home to qualify for a second mortgage. Many lenders want you to keep 10% or 20% of your equity after closing on a second mortgage, so take that into consideration before applying.
• Credit score. Each lender is different, but you'll probably need at least a 620 credit score. To improve your credit score before applying for a second mortgage, make sure you're paying all your bills on time. You can also let your credit age and pay down debts.
• Debt-to-income ratio. Your debt-to-income ratio is the amount you pay toward debts each month, divided by your gross monthly income. Lenders usually want to see a DTI ratio of 43% or less for a second mortgage, but again, it depends on the lender. Look into paying down some debts to lower your ratio, or think about any opportunities to earn more money.

If you qualify for a second mortgage, the next step is to determine whether applying for one is the best choice for you.

Second mortgage: Pros and cons

Like any big purchase, a second mortgage has its pros and cons. Here are some factors to consider:

A second mortgage can be a good tool for covering large purchases, especially if you've gained a good chunk of equity in your home. Just make sure it's the right financial move for your situation.

Second mortgage FAQs

Are second mortgages a good idea?

A second mortgage may be a good idea if you want to cover a big expense, because rates are lower than on alternatives such as credit cards and personal loans. But know that you risk foreclosure if you can't make payments on the second mortgage.

What does getting a second mortgage mean?

Getting a second mortgage means you now have a second home loan along with your initial mortgage, and you'll make payments on both. With a second mortgage, you borrow against the equity you've built in your home by making payments or by your house accumulating value.

How much can I borrow for a second mortgage?

Many lenders want you to keep 20% equity in your home after taking out the second mortgage. So if you have 50% equity in your home, you can borrow 30% so that 20% will remain.

What is the maximum amount for a second mortgage?

The maximum amount you can borrow with a second mortgage is usually 80% of your home's value — and that's assuming you have fully paid off your first mortgage. Basically, lenders typically want you to have 20% home equity remaining after you take out the second mortgage.