Taking Out a Second Mortgage

Second Mortgages Explained

A second mortgage, or home equity loan, lets you borrow money against the equity in the appraised value of your house. If your home’s value is put at $200,000 but you only owe $150,000 on your current mortgage, you have $50,000 in home equity.

Lenders let you borrow anywhere between 80% and 95% of that home equity, using your home as the collateral against the loan. The funds are delivered as a lump sum and you’ll begin repayments over a fixed period of time. Your monthly payment amount won’t change over time, so you’ll know exactly what to expect.

In order to qualify, you’ll need to get approved through a lender. This doesn’t necessarily have to be the same mortgage lender you work with; instead, you can pick anyone approved in your state in order to get the best terms possible.

As part of the initial application, the lender will review the following criteria:

• Your credit score
• Your debt-to-income ratio
• The amount of equity in your home

To complete that last piece of the puzzle, the lender will order an appraisal of the home, which determines the current home value. You’ll generally have to pay this cost out-of-pocket, which can be a few hundred dollars, depending on where you live. Once your application is complete and is approved by your lender’s underwriter, you’ll be able to close on the loan and receive your funds.

Because your home’s value is involved, it can take 30 days or longer to complete the entire process for a second mortgage, making it much slower compared to a personal loan.

Why Use a Second Mortgage

One of the perks of getting a second mortgage is that you can use the funds for just about anything. Whether or not this is the best idea is up to you, since your home is being used to secure the loan. Common reasons why homeowners take out home equity loans include:

• Debt consolidation or credit card/loan payoff
• Home improvement projects
• Large purchases like a new car
• Education
• Life events like a wedding or adoption
• Medical debt

It’s really important to weigh the importance of your fund use against the inherent risk involved with a second mortgage. Just like any type of financing decision, you really need to prioritize to make sure your extra expenditures are manageable within the context of a second mortgage.

Pros and Cons

The biggest advantage of a second mortgage is that the interest rates are generally much lower compared to other types of financing, such as a personal loan or credit card. You’ll also receive a fixed rate on the new loan, so you can be consistent with your payments each month and easily plan ahead.

The major downside, however, is that if the real estate market drops in your area, you could easily become underwater on your home because you don’t have as much equity as you once did.

If you need to sell your home at any point, a second mortgage limits the flexibility you have in your asking price and may take you longer to find a buyer.

On top of that, if you lose your job or can’t work anymore for some reason, you have less breathing room each month when you have two mortgage payments to make. Defaulting on even your second mortgage could result in going into foreclosure if you can’t make your payments on time. Consequently, it’s a huge risk and should be appropriately weighted before making a final decision.

Finally, a second mortgage comes with a few logistical disadvantages. As briefly mentioned, closing is much longer compared to other types of loans. In fact, it can take anywhere between 30 and 45 days depending on how busy the lender and appraiser are at the time.

You may also have to pay closing costs as part of your second mortgage, which can range between 2% and 5% of your borrowed amount. If you borrow $30,000, for example, you could pay an additional $600 to $1,500 to your lender.

Other Financing Alternatives

When you’re not sure if a second mortgage is right for you (or if you don’t have enough equity in your home), consider one of these financing alternatives.

Home Equity Line of Credit (HELOC)

A HELOC still uses your home equity to secure the funds, but you can simply tap into an approved line of credit little by little, rather than getting a lump sum all at once. This comes with a few distinct advantages. For one, you only pay interest on the amount you borrow. As you pay it back, you can borrow more or rest easy knowing that you have a back-up line of credit available should you need it.

Another advantage is that you can pace yourself as you monitor your local real estate market. If you notice a dip in sales prices nearby, you may decide to stop tapping into your HELOC. Of course, your ability to do that depends on what the funds are being used for.

Unsecured Personal Loans

You won’t get the same low rates as you would with a second mortgage, but an unsecured personal loan doesn’t require any of your property as collateral. If you default, you’ll still face some financial and credit repercussions, but you won’t be at risk of losing your home.

Another benefit is that you don’t need excellent credit to apply for a personal loan. You can find lenders willing to work with a range of credit profiles, whereas most home equity lenders tend to approve only those with stronger credit.

Credit Card

You may not be able to use your credit card for everything (and you probably shouldn’t, anyway), but if you’re in a cash crunch, you could consider financing an emergency this way rather than taking the risk of a second mortgage.

Frequently Asked Questions

by Lauren Ward

Personal Finance Writer

Lauren Ward is a personal finance writer with nearly ten years of experience covering topics like loans, credit, and real estate. She lives in Virginia with her husband and three children.