All About Second Mortgages

If you've owned your home for a while, you may have considered tapping into your home equity through a second mortgage. While not as popular or plentiful as they were a decade ago, second mortgages are still around and can make for a good financial move, under the right circumstances. Before you jump into shopping for a second home loan, here's what you need to know.

What Is a Second Mortgage?

Second mortgages come in two varieties: home equity loans and home equity lines of credit (HELOC). With a home equity loan, you get a lump sum upfront and repay it over regular intervals, usually with a fixed interest rate, much like your first mortgage. A HELOC lets you tap into a revolving line of credit, with no set repayment schedule and a variable interest rate. The value of your HELOC can be reused as you pay down your balance, in some ways, it's very similar to having a credit card.

Uses of Second Mortgages

A first mortgage has one use: to purchase real estate property. Second mortgages are not so restrictive, though. You can use a second mortgage to make important, high-dollar purchases that may or may not be related to your home. Many use a second mortgage to pay for home repairs or improvements, for instance, but other options include financing a college education, purchasing a car, or paying off credit cards or other high-interest debt. What you want to do with the money should help you decide between a loan and a line of credit. If you need to make a single large purchase, you will do better to get a home equity loan, since you can likely get a better interest rate. If you need access to cash here and there, a line of credit may be best.

How Second Mortgages Work

When you apply for a second mortgage, you're essentially borrowing against your ownership stake in your house. The loan amount or line of credit you can get is restricted to the share of the property that isn't financed. For instance, if your home is worth $350,000 and your mortgage balance is $250,000, you have $100,000 equity from which to borrow. That's not to say that a lender will allow you to borrow that whole sum through a second mortgage. Many lenders restrict second mortgages, such that the sum of your first and second mortgage can't exceed 75 or 85 percent of the total value of the home. In this case, that means you could get a line of credit or home equity loan worth between $12,500 and $47,500.

How Second Mortgages Are Different from Other Loans

What makes second mortgages different from other short-term loans or consumer credit cards is the fact that they are tied to your home. A second mortgage places a second lien on your property, meaning your loan is secured by your home. Unlike a personal loan or credit cards, you could face foreclosure if you don't make your payments. However, it's also this fact, that your home is collateral for the loan or line of credit, that allows many people to be able to borrow in the first place. Interest rates for home equity loans and HELOCs are generally higher than for first mortgages. Yet, for the moment, they're also fairly low. A quick survey of Bankrate shows most offers are around 1.5 to 3 percent higher than the current average of 3.72 percent for 30-year fixed-rate mortgages reported by Freddie Mac. Second mortgages differ in other ways, too. Unlike some loans, you may be able to deduct interest paid on a second mortgage on your taxes. Check with your tax advisor to know for sure. You also may end up owing closing costs on some types of second mortgages, so talk to your lender see what options are available before moving forward. Lastly, you'll likely need to have a title search performed to ensure there are no problems with the ownership of the property and purchase a title insurance lender's policy, just as you did for your first mortgage.

Second Mortgages Then and Now

Second mortgages aren't as popular or as easy to get as they once were. The practice of having a second mortgage peaked around the same time as the housing boom. According to a RealtyTrac survey, HELOC originations accounted for nearly one in four mortgage originations in 2005. Now the number is closer to 15 percent. Today, it's more difficult to get a second mortgage and lenders have instituted safeguards, such as higher credit standards and LTV restrictions to avoid unnecessary risk. However, for many homeowners, a home equity loan or line of credit can serve an important purpose. As with any home mortgage, it's important to shop around, do your research, and ask questions to make sure you choose the right lender and the right mortgage loan.