How Does A Second Mortgage Work?

A second mortgage option is given to you on top of your already existing primary mortgage.

Everyone is well aware of what a primary mortgage is: you pick a home you like, you submit an application to the mortgage lender, they review your creditworthiness and then (if you’re lucky), will grant you the loan.

This is the most common process of a primary mortgage. Now you’re just paying off the principal amount that you borrowed, plus the interest for a specified amount of time, until your mortgage is fully paid off.

What if you have another major expense coming up? Sending a kid off to college, maybe? And it’s true that once you already have a pending loan to be paid off, there are chances that you won’t be accepted for any other loan.

That is where you have an option for a second mortgage.

How does a Second Mortgage work?

The primary mortgage which has been lent to you stays there; you have been given an amount which you have to pay with interest in monthly installments. Once you pay the whole loan, that is when you’re officially the owner of the loan.

What if you have another major expense that needs to be taken care of? Maybe a student loan debt or a wedding planned in the next couple of months? It is very much possible that you’re not given another loan because you haven’t paid off your primary mortgage yet.

That is when you have the option of a second mortgage- meaning borrowing against the equity of your home. A second mortgage helps homeowners get a smaller loan against their home equity- which is also known as the home equity loan.

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Second mortgages are also to be repaid within a specific period of time, with an interest rate decided upon the beginning of the agreement. The second mortgage interest rate is relatively higher. This is because the borrower is likely to default on the second mortgage, because payment for the first one is the priority. And of course, the second mortgage has to be fully paid before another loan can be obtained against home equity.

Second Mortgage Example

How second mortgages work is fairly simple, but with all the math involved, it can be a little tough to understand. Here’s an example:

Martin has an auto loan. The balance is $10,000, with an interest rate of 9% and two years are left on the term. Consolidating that debt to a home equity loan at a rate of 4% with a term of five years would actually cost him more money if he took all five years to pay off the home equity loan.

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And now, his home is collateral for the loan instead of his car. So if Chris defaults on the loan, he could lose the house which would be more dangerous than him losing his car.

That is how a second mortgage works.

Second Mortgage Requirements

Just a recap: if a borrower has a first and second mortgage, and they default on the loan, the first mortgage lender has the right to go after your house (collateral). This makes the job of second mortgage lender A LOT riskier.

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So, a second mortgage lender has a stricter criteria as requirements too. Here is what is essentially required from the borrower:

  • Equity: The second mortgage lender cares about equity- and lots of it. The borrower must have more than 20% equity on their home. They will probably hire an appraiser to calculate the exact amount of equity on your house. And that way you can see how much of a second mortgage loan you can borrow.
  • Credit rating: Usually a good credit score is required for a second mortgage, usually 620. This will get you a competitive rate in the market and maybe a lower interest rate than usual.
  • Debt-to-income ratio: This metric shows how much debt you already have against your monthly income, and mortgage lenders want it to be less than 43%. That is how you will qualify for a second mortgage.

Second Mortgage Loan Calculator

A second mortgage loan calculator is an online tool that tells borrowers how much they can borrow against their current home equity. It is always best to consider the numbers before approaching a second mortgage lender so you have an idea of what to expect.

How much loan you can borrow actually depends on how much credit rating you have, your DTI, income, home equity and several other factors. If you feel your current credentials are not enough for a bigger loan amount, you can take certain measures to improve it, such as:

  • Bigger down payment
  • Reducing debt even by a short percentage will help you
  • Improve credit score by timely payments

How much you can borrow depends on your credentials and the calculator will give you an even better estimate of what you should expect. It is important to make sure to borrow only what you need, because you also have a primary mortgage on your shoulder.

And before you even begin to pay off the second mortgage, you will have to first get rid of the first one. So you’re actually looking for decades of debt and loan that needs to be paid. Make sure all your options are properly weighed down before you even look for another mortgage. Also, it is always better to shop around for the best rates and low interest so that your budget isn’t shook to the core.

Second Mortgage Interest Rates

Second mortgages often have lower interest rates than other types of debt. Again, securing the loan with your home helps you because it reduces the risk for your lender. Because the loans are lower risk, lenders offer lower rates on second mortgages than unsecured personal loans like credit cards.

Provider Loan Types Loan Rates Loan Amounts
Discover HEL Fixed starts at 3.99% $35,000 to $200,000
Alliant Credit Union HELOC Variable starts at 4% Up to $250,000
Bank of America HELOC can convert to HEL Varies by state $25,000 to $1 million
PenFed HELOC 3.75% – 4.75% variable $10,000 to $400,000
Citi HEL and HELOC HEL fixed at 6.59% to 6.62% APR and HELOC variable at 3.99% APR HELOC $10,000 to $1,000,000 and HEL $25,000 to $300,000

Note: Sample rates have been extracted online, courtesy of Interest.

How far in advance should I get pre approved for a Mortgage?

There is no time limit or a hard and fast rule about this, but most experts advise that you should apply for pre approval before you even start looking for a home. This is because you will know exactly what type of house you can afford to buy.

Sometimes people find a house they love, and it often exceeds their pre approval budget and they have to start looking for a cheaper option again. So having pre approval before looking for a house saves you from the disappointment and heartbreak of letting go of the house you really loved.

Typically it takes somewhere between one to three days if you have all your documents ready. The loan officer only has to go through the documents, verify the information and issue you a letter.

However, debts or extensive credit information could slow down the process and stretch it to a week even. It is always advisable for people to have all their recent documents and papers ready before they apply for mortgage. This way getting a preapproval on mortgage is easier and less time consuming.

How to get a Second Mortgage to buy another house?

People are usually so keen on a second mortgage because they want to buy another property: an office, land or even another house. This is possible; all you have to do is find a second mortgage lender and fill out an application. The condition is that this time you will only get a mortgage against the equity of your home.

And that will be the maximum amount that you’re allowed.

Second mortgages are given out through three sources:

  • Bank
  • Trust company
  • Private mortgage lender
Lender Example Company Product Interest Rate Credit Score Minimum Equity
Major bank TD Bank Home equity line of credit 2.50% 650-900 25%
Trust company Home Trust Mortgage (in second position) 15.00% 550-700 10-15%
Private mortgage lender Tridac Mortgage Corporation Mortgage (in second position) 10.00% Less than 600 10% or less

Note: Sample rates have been extracted online, courtesy of RateHub.

Conclusion

Nowadays everyone has their house on a mortgage; they spend decades trying to pay off the loan amount including the interest rate that is decided in the beginning. And when your primary mortgage loan is going on, you won’t be given another loan for any other expense any way.

That’s where a second mortgage comes in. Against the equity of your home, you are given another mortgage to buy some other property or another house. Whatever the equity of your home is, which is the total value minus any mortgage, that is the maximum amount that you’re allowed to borrow.

Now you have two mortgages to pay back, so make sure you know what you’re getting yourself into before agreeing on a second mortgage.

Tony Bennett

Tony Bennett

Tony Benett makes his living in the insurance industry by teaching and consulting. He is also recognized by the legal profession as an expert on insurance coverages. His insurance experience includes having worked at the company level, owned an independent general agency and having worked for an insurance association. He has received various certificates over the past few years and helps his clients and readers by giving them a realistic outlook on what they can expect to achieve within their set targets. At Insurance Noon, he is known for his in-depth analysis and attention to details with accuracy. He has been published as one of the most referred agents by his peers in the insurance community. Tony loves the outdoors and most sport events. His passion other than providing excellent advice is playing golf.

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