A second mortgage is a loan secured by real estate when there is already another loan on the property. Second mortgages are sometimes called junior liens.
Your home can serve as collateral for a few different loans at once. You might get a second mortgage to pay for a big purchase or to finance a home improvement project. Or, you might take out a second mortgage when you purchase a home to avoid paying private mortgage insurance.
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What’s the Difference Between a First Mortgage and a Second Mortgage?
A first mortgage is the home loan that you use to buy a property or to refinance, while a second mortgage is an additional loan that’s also secured by the equity in your home.
In case of foreclosure, a first mortgage is paid off first, and the second mortgage is repaid with the remaining proceeds of the home sale. This means second mortgages are riskier for lenders, so a second mortgage is often more expensive.
“The reward is a little higher of an interest rate because they’re not in first position,” says Suzanne Downs-Buono, president of Palm Beach Mortgage Group.
While lenders often sell first mortgages to Fannie Mae or Freddie Mac, the government-sponsored enterprises don’t buy second mortgages. Lenders may sometimes sell second mortgages to investors, but more often, they hold onto second mortgages in their own portfolios.
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How to Qualify for a Second Mortgage
Applying for a second mortgage is similar to applying for a first mortgage. You can usually get started online, over the phone or in person. Expect to provide your name and Social Security number, plus details about your employment. You’ll need to share information about your income and assets, and the lender will check your credit history.
The lender will also need information about the home that you’re using as collateral.
Requirements vary between lenders. “Some might do a lower credit score than others,” Downs-Buono says. “And then some will do 80% loan to value. Some will do 90% loan to value.”
Types of Second Mortgages
Lenders offer a few main types of second mortgages to suit different borrowing needs.
Home Equity Loans
If you take out a home equity loan, you receive the entire amount that you’re borrowing at closing. Then, you make regular payments of both principal and interest over a set period, typically five to 30 years. The interest rate on a home equity loan is fixed, so you know in advance how large your payments will be.
A home equity loan can be a good choice when you know how much money you need upfront — for instance, to consolidate debt, pay a contractor for a home renovation or finance a large purchase.
“Typically those home equity loan rates will be a little bit more compelling than a home equity line of credit,” says Daniel Bauer, head of residential lending at Alliant Credit Union.
Piggyback Loans
A piggyback loan is a second mortgage that’s used to cover part of the purchase price of a property. The first mortgage and the piggyback loan close together.
Getting a piggyback loan may allow borrowers to avoid paying PMI. Borrowers usually have to pay PMI if they make a down payment that’s under 20%. With a piggyback loan, they can put down a lower amount and borrow to make up the difference. For example, a homebuyer might take out a first mortgage for 80% of the home’s value and a 10% piggyback second mortgage. They could then put just 10% down without owing PMI.
A piggyback loan can also be helpful for homebuyers who want to borrow more than the conforming loan limit, which some lenders won’t exceed. Borrowers can take out a first mortgage up to that limit and make up the difference with a piggyback loan.
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HELOCs
A home equity line of credit allows you to borrow against the equity in your home, up to an approved limit. You can tap your credit line, pay it back and borrow again as often as you want during the first few years of the loan term, which is called the “draw period.” You only pay interest on the amount you actually borrow. HELOC payments during the draw period are often interest-only, but you can pay more. The draw period for a HELOC runs between five and 15 years, with 10 being the most common.
When the draw period is up, you enter the repayment phase. You must make regular payments covering both interest and principal to clear your balance by the end of the loan term.
Traditional HELOCs have variable interest rates.
HELOCs offer more flexibility than a home equity loan and could be used for unpredictable expenses or ongoing needs. “When you are looking for access to capital that you might not necessarily be looking to use immediately, the home equity line of credit can make more sense,” Bauer says.
Fixed-Rate HELOCs
Fixed-rate HELOCs are new to the market and are a flexible alternative to fixed home equity loans. Fixed rates can make the loan more stable. Some lenders require you to make a large initial draw when you open the account. Expect to pay a higher interest rate than you would with a variable-rate HELOC.
Hybrid HELOCs
A hybrid HELOC comes with a fixed interest rate for an initial period that typically lasts two to four years. After that, the interest rate varies as on other HELOCs. Some HELOCs have variable rates but offer the chance to fix your rate when you enter the repayment phase. Others allow you to convert part or all of your balance to a fixed rate at one or more times during your loan term.
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What Is a Second Mortgage? originally appeared on usnews.com
