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Most homebuyers who borrow money to purchase a home or investment property will take out a first mortgage. But those who wish to borrow additional funds, either for down payment assistance or to pull out equity from their property, can get a second mortgage. Learn what a second mortgage is, when second mortgages are typically used, and the pros and cons of getting a second mortgage.
What is a second mortgage?
When you borrow money from a bank or lending institution to buy real estate, you receive a mortgage, which is a lien that securitizes the lender, often referred to as a first-lien mortgage.
A second mortgage is a separate loan that is subordinate to a pre-existing first mortgage, putting the second mortgage lender in a secondary position behind the first mortgage lender.
In the event a borrower defaults, or stops making payments, the first mortgage lender will be paid before the second mortgage lender. A second mortgage is typically a smaller loan amount and is considered a second mortgage because it is originated and recorded in public records after the first mortgage.
Second mortgage types
One of the most common second mortgage types is a home equity loan, which allows property owners to borrow against their property's equity. Equity is the market value of the property in relation to the loan amount. As the mortgage loan is paid down or the property's value increases, equity is built. If a borrower has enough equity in their home, they may be able to qualify for a home equity loan, which provides the borrower with either a lump sum or line of credit to use as cash, repaying the borrowed amount over time.
In lump-sum second mortgages, the borrower receives the entire amount upfront, often with fixed interest rates and fixed monthly payments.
In a line of credit second mortgage, which is called a home equity line of credit (HELOC), the lender establishes a maximum line amount and draw period where the borrower can withdraw funds as needed up to a maximum borrowing limit. HELOCs often have variable interest rates that adjust based on the amount being used at a given time.
Example of a home equity second mortgage
|Mortgage type||Date Created||Loan Amount||Interest Rate||Term of Loan||Payment|
|First-lien mortgage||5/1/2020||$150,000||4.5%||30 years||$760.03|
|Second-lien mortgage||12/1/2028||$25,000||8.5%||10 years||$309.96|
Down payment assistance
Another less popular type of second mortgage is down payment assistance. Some lenders, government agencies, non-profits, or companies offer financial assistance to borrowers, giving them a portion or all of the funds needed for a down payment on a home loan. Depending on the program, the lending institution may record a second mortgage for the down payment amount with or without repayment requirements.
For example, if you had only $2,000 to put down on a home and were qualified to receive a mortgage for $110,000 with a down payment assistance program, you could get a second mortgage for the remaining $8,000 needed for the down payment.
|Mortgage type||Date Recorded||Loan Amount||Interest Rate||Term of Loan||Payment|
|First-lien mortgage||5/1/2020 at 1:45 p.m.||$100,000||4.5%||30 years||$760.03|
|Second-lien mortgage||5/1/2020 at 1:50 p.m.||$15,000||2%||10 years||$309.96|
Most down payment second mortgages will specifically state that the loan is subordinate to the first mortgage, referring to the first-lien mortgage lender and loan amount.
Pros of second mortgages
Get cash now
One of the most obvious benefits of getting a second mortgage is being able to utilize your property's equity, receiving cash to use in a variety of ways, including:
- For home improvement projects.
- To help pay off debt with higher interest rates.
- For the down payment on another investment property.
Or simply use the money as you please.
Cons of second mortgages
One of the most obvious cons of getting a second mortgage is that you are reducing your property's equity by taking on additional debt. If the market turns and your property value decreases, having a second mortgage could place you underwater or eliminate any equity you once had in your property.
Risk of losing your property
Additionally, if you stop making your payments, you're putting your home or property on the line. The second mortgage lender has just as much of a right to pursue foreclosure or legal action to collect their debt as a first mortgage lender, even if you're still paying your first mortgage.
Another con is the high cost of a second mortgage. Second-lien mortgage loans often charge a higher interest rate than a traditional first-lien mortgage would, with added fees for closing costs like loan origination, appraisal, and underwriting fees.
Even if you have equity in your home, or need assistance for a down payment, you may not qualify for a second mortgage. Most lenders have specific requirements, such as a minimum equity percentage, credit score, or market value. While getting a second mortgage is an option for many, it's not available to everyone.
Second mortgages in summary
|Pros of Second Mortgages||Cons of Second Mortgages|
|• Get money now from your property's equity.
• Can use the funds for down payment assistance, home renovations, or as you please.
• Reduces the equity you have in your property.
• Creates additional debt and risk.
• Can be a high-cost loan.
• Is not available to everyone.
If you're interested in getting a second mortgage, learn more about the lending requirements and talk with a mortgage broker or banker to see if you would qualify. Remember that utilizing the additional money that can be provided through a second mortgage is taking on additional debt. Always look at the cost of borrowing, and make sure the additional funds now are worth the financing cost in the long run.
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