A second mortgage is a second lien on your home. Some people take out a second loan when they buy their house. The second lien helps cover the necessary down payment for the first mortgage. Others take out a home equity line of credit or home equity loan after they own the home. No matter what you call it or when you take it out, the result is the same – you have two mortgages that you must pay on your home.
The Definition of the Second Mortgage
The second mortgage has the name because it takes second lien position on your home. The loan you use to purchase the home is the first lien. This loan has priority. Should you stop making your mortgage payments, the first mortgage holder receives payment first from the foreclosure proceedings. The second mortgage lender is next in line for payment.
Using Your Home’s Equity
You only qualify for a second mortgage when the home is worth enough to cover the combination of the first and second mortgage, plus the required amount of equity in the home. If a lender allows a loan-to-value ratio of up to 85%, both your first and second loan must not be more than 85% of the home’s value. For example, if a home is worth $200,000, you can have a combination of loans that total up to$170,000.
Taking Out a Second Mortgage to Buy a Home
You can use a second mortgage to buy a home. Some people call it a piggyback loan. You use the second mortgage as a part of your down payment on the home. Typically, piggyback loans have an 80/10/10 structure. This means that 80% of the home’s price comes from the first mortgage, 10% comes from the second mortgage, and 10% comes from your own down payment.
The second lien helps reduce the amount of money you need to bring for a down payment. It also eliminates the need for Private Mortgage Insurance. If you borrow more than 80% of the home’s value in a first mortgage, you will pay PMI, if you use a conventional loan.
Taking Out a Second Mortgage After Owning a Home
If you already own a home, but want to tap into the equity, you can take out a second mortgage. You can do this with a home equity line of credit or a home equity loan.
The home equity line of credit works like a credit card. You get a line of credit that you can use as you need. You only make payments on the money you withdraw or use. For example, if you have a $20,000 credit line, but leave it untouched, you don’t owe any payments. If you use some of it, say $5,000, you would make interest-only payments on the $5,000 you withdrew. You can keep using the funds until you tap out your credit line. If you pay any of the principal back, you can reuse the credit line, just like a credit card. You can do this for 10 years. After 10 years, you make required principal and interest payments and cannot withdraw funds any longer.
The home equity loan provides funds to you in a lump sum. Let’s say you borrow $20,000 from your home’s equity. You would receive the $20,000 in hand at the closing. You don’t have a credit line to draw on, though. You also make principal and interest payments (typically fixed payments) for the term.
Reasons to Use a Second Mortgage
Aside from purchasing a house with the funds from a second mortgage, there are a few more uses:
- Home renovations – Repairing, remodeling, or renovating a home can be expensive. Using the money from your home’s equity is a great way to fund the repairs/renovations while increasing the value of your home.
- Debt consolidation – If you have a lot of credit card debt and a decent amount of home equity, you can wrap the debt into your home with a second mortgage. Just be careful with this because you make unsecured debt secured by using your home as collateral.
- Large Expenses – College education, buying a car, or taking an expensive vacation are all reasons people take out a second mortgage.
A second mortgage can help you afford large expenses in your life, consolidate debt, or even help you buy a home. Remember that the second lien uses your home as collateral. Make sure you are comfortable with the payments. Defaulting on the loan could put your home at risk. A second house loan can be a great way to get the financing you need, though. Shop around to find the best deal for your situation.