What Is a Second Mortgage, and How Does It Wor

The need for money can arise at any moment. Whether it is for consolidating debts, home renovations, or higher studies, homeowners have the option to get a mortgage on their house not once but twice. 

A second mortgage is a type of financial tool. You can consider it as a home loan. It plays a significant role in the financial strategy of any homeowner. Let’s start by looking into what a mortgage is before diving into the meaning of a second mortgage and how it works.

What Is a Mortgage?

If you own a house, then you can take a loan on the house. In this case, you are the borrower, and the person who gives you the money is the lender. The borrower agrees to pay back the money over some time via monthly payments, and the house serves as collateral. 

The total payment amount includes the total amount borrowed and the interest. If the borrower defaults in payment, then the borrower is exposed to either legal claims or foreclosure of the house.

What Is a Second Mortgage?

A second mortgage is a loan one can take against a property against which a loan has already been taken. It is also known as a home equity loan or junior lien. Here, the first mortgage agreement is intact, and the amount the borrower needs to pay for the first loan is still outstanding. 

There are many reasons why a homeowner might choose to get a second one on their home, such as finance for college, new vehicles, home improvements, or a down payment on a second home.  

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Types of Second Mortgages

Depending upon the lender, a second mortgage is offered in various forms. However, there are two main types:

Home equity loan

Herein, the borrower gets the whole amount at once at a fixed interest rate. The borrower then makes fixed monthly payments till he pays the whole amount plus interest.

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Home equity line of credit (HELOC)

In this, the borrower can get the money all at once, but he also has the option to get the amount over time as and when needed. The interest rate varies. During the 10-year drawing period, the borrower makes a monthly payment of merely the interest. After this period is over, the repayment begins.  

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How Does Second Mortgage Work?

If you get a second mortgage, some lenders allow you to borrow up to 85% of the home’s equity; however, its amount will be lower than that of the first mortgage. The interest rate would be higher in comparison to the first one, but it is lower than a personal loan or credit card. The payback for it starts when the first loan has been paid off.

If there is any default in payments, the first mortgage will receive all the proceeds from the property’s liquidation, and then, the proceeds would go to recover the second one. If the proceeds from the property’s liquidation aren’t enough to cover both mortgage amounts, the lender incurs a loss.   

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Steps to Get a Second Mortgage

If you want a second mortgage, follow the following steps:

Assess whether you are qualified to get it

If you have taken a loan against your house and are still paying for it, you may be entitled to get a second one. Its requirements include:

  • A credit score of  620 or higher
  • Debt to income (DTI) ratio of 43% or lower
  • Decent amount of equity on the first home 
  1. Determine the amount you can borrow 
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Calculating your home equity can help determine how much money you can borrow from a lender when you go to one. 

Pick a lender

Compare and contrast potential lenders. Pick the one that gives you the best terms and low-interest rates. 

Submit your application

After choosing the lender, you need to apply for it. Fill out the form and give the information on your personal finances. The required documents for this include documents of income, debts, and assets. The lender will assess this information and see whether you qualify for the loan or not. If yes, then what terms they can offer.

Get the necessary appraisals and inspections done

You need to get an appraisal if your property has not been appraised in 3-6 months. Also, the lender may need you to get it done to ascertain the current market value of the property.  Additionally, the lender may also require you to conduct certain inspections to determine the property’s standards.  

Close and secure loan proceeds 

This step starts after the lender accepts your application, you get the appraisal, and the inspection is done too. You will close the loan and receive the money. 

Final Thoughts

For any homeowner, a second mortgage is a valuable financial tool. It allows a homeowner to get a loan against a house on which the first loan is still outstanding. There are many things to consider when taking a second mortgage on a house. Most homeowners are attracted to this option because the interest rate may be higher than the first mortgage, but it is lower than a personal loan or credit card. 

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