A second mortgage is a loan made in addition to the homeowner’s primary mortgage. When most people purchase a home or property, they take out a home loan from a lending institution that uses the property as collateral. This home loan is called a mortgage, or more specifically, a first mortgage. The borrower must repay the loan in monthly installments made up of a portion of the principal amount and interest payments. Over time, as the homeowner makes good on their monthly payments, the home’s value also appreciates economically.

The difference between the home’s current market value and any remaining mortgage payments is called home equity. A homeowner may decide to borrow against their home equity to fund other projects or expenditures. The loan they take out against their home equity is a second mortgage, as they already have an outstanding first mortgage. The second mortgage is a lump-sum payment made out to the borrower at the beginning of the loan.

A second mortgage is “subordinate” and holds the second lien position. This means that in the event of default, the original mortgage which has priority because it’s in the first lien position, would receive all proceeds from the property’s liquidation until it is paid off. Meaning the first mortgage lender gets paid before the second mortgage lender. This means that second mortgages are riskier for lenders that ask for a higher interest rate on these mortgages than on the original mortgage. If there are any remaining proceeds, they will then be used to pay off the second mortgage which now stands alone because it is no longer tied to the first. Second mortgage programs require immediate repayment like a traditional mortgage and do not allow you to defer payments.

Since the first or purchase mortgage is used as a loan for buying the property, many people use second mortgages as loans for large expenditures that may be very difficult to finance. For example, people may take on a second mortgage to fund a child’s college education or purchase a new vehicle.

Requirements for a Second Mortgage: To qualify for a second mortgage, you will need to meet a few financial requirements. You will need at least a credit score of 620, a debt-to-income (DTI) ratio of 43%, and a decent amount of equity in your first home. Because you are using the equity in your home for the second mortgage, you will need to have enough to not only take out your second loan but also be able to keep approximately 20% of your home’s equity in the first mortgage.

Pros:

1.  Interest rates on second mortgages are lower than on private loans or credit cards.
2. Lenders have accommodated the buyers’ needs and now there are more Non-QM, Fixed, Variable, Interest Only options on the market than ever before. This has opened the doors for many borrowers, who in the past may not have been able to qualify for a second mortgage. The shift to meet borrowers’ demands has eliminated limitations on program selection. Giving the borrower more options and more control.
3. Most lenders will allow you to borrow at least up to 80% of your home’s value, and some lenders will let you borrow more.
4. Homeowners might use a second mortgage to finance large purchases like college, a new vehicle, or even as a down payment on a second home.
5. Second mortgages can also be a method to consolidate debt by using the money from them to pay off other sources of outstanding debt, which may have carried even higher interest rates.
6. You receive a lump sum payment immediately.

 Cons:

1. You need a decent amount of equity in your home to take out a significant second mortgage loan. – If the appraisal comes back with a low value, (ex. The homes in the neighborhood did not appreciate and were sold for a lower price bringing the median home value down, there is significant damage to the home, new commercial construction has started within earshot, the home is outdated, etc…) the borrower may not be able to meet the loan-to-value requirements resulting in disqualification from that program. The first loan balance + the second loan balance is divided against the appraised value of your home. For example, a property with a first mortgage balance of $300,000, a second mortgage balance of $100,000 and a value of $450,000 has a CLTV ratio of 89%. This means there is only 11% equity and will not meet the lenders’ qualifying requirements.
2. It costs money to take out a second mortgage, as you must pay the closing costs up front, like a first mortgage.
3. Second mortgages often have higher interest rates than first mortgages but lower interest rates than a personal bank loan or credit card payment.
4.  If you can’t pay back a second mortgage, you risk losing your home.

If your home doesn’t appraise high enough and you don’t have enough equity in your home, you may not qualify for a second mortgage loan. – Majority of those who do not qualify based on those reasons, can usually qualify for a HELOC.