What is a second mortgage and how do you qualify for one?

If you’ve owned your home for a while and need funds to pay off credit card debt, to cover tuition or for another expense, a second mortgage may be a good option. A second mortgage is a second loan that uses your home as collateral. Your primary mortgage stays in place, and you make two monthly mortgage payments.

Is a second mortgage worth the risk? How do you qualify for a second mortgage? What types of second mortgages are available? In this resource, we explore these topics and others so you can decide whether a second mortgage is right for you.

What is a second mortgage?

A second mortgage is a loan that uses your home as collateral while you still have a primary mortgage.

While many loans are issued for a very specific purpose (e.g., student loans, auto loans), the funds from a second mortgage can be used for just about anything. This gives homeowners a great deal of flexibility. Homeowners commonly use a second mortgage for large, one-time expenses such as:

• Paying off credit cards
• Paying off student loans
• Paying for major home improvement projects

The loan is called a second mortgage because if you no longer can pay off the loan and the home is sold, the lender is paid off after the primary mortgage lender. While a second mortgage is an attractive path toward debt consolidation or home renovation, the flip side is that a second mortgage can extend the years you spend in debt.

Types of second mortgages

There are three main types of second mortgages: piggyback loans, home equity lines of credit (HELOCs) and home equity loans (HELs). Sometimes, you hear the phrase “stand-alone second mortgages,” which refers to mortgages that are taken out after the original loan. Both HELOCs and HELs are considered to be stand-alone second mortgages.

There are three main types of second mortgages.

• Piggyback loan: This kind of second mortgage is taken out at the same time as the primary mortgage. It is sometimes known as an 80-10-10 loan because it combines a primary mortgage for 80% of the home’s cost with a second mortgage for 10% of the home’s cost; the buyer makes a 10% down payment.
• Home equity line of credit (HELOC): A HELOC is a revolving line of credit, similar to a credit card. It allows you to borrow up to a specific limit and pay back only what you take out. The interest rate is normally variable.
• Home equity loan (HEL): A home equity loan provides you with a fixed amount of money that must be paid back over time.

Second mortgage vs. home equity loan

A home equity loan is a type of second mortgage in which you receive a portion of your home’s equity as a lump-sum payment. Based on how much equity you have, your income and your credit history, you can borrow up to 85% of the value of your home. You make regular monthly payments to pay back the loan.

A home equity loan is the simplest form of a second mortgage. As with other types of loans, it’s important to shop around at different lenders for the best terms.

Second mortgage vs. refinance

A second mortgage is not the same as a mortgage refinance. In a mortgage refinance, you are replacing your current mortgage with a new one. With a second mortgage, you are adding a new mortgage.

A mortgage refinance can be an opportunity to negotiate a lower interest rate or change your loan term. A cash-out refinance is a type of refinancing that allows you to tap into your home equity and get cash as part of the new loan.

How does a second mortgage work?

A second mortgage provides a loan based on your home’s existing equity, which is the difference between your home’s current value and the balance on your mortgage.

As an example, let’s say you have a $150,000 balance remaining on your mortgage, and your home is valued at $250,000. That means you have $100,000 in home equity.

When you take out a second mortgage, you are taking advantage of the equity in your home. Typically, lenders won’t allow you to receive your total equity through a second mortgage, preferring that you retain at least 15% equity. This means, in the example above, that you would need to retain at least $37,500 of equity, giving you the potential to borrow up to $62,500.

How to get a second mortgage

If you decide that a second mortgage is right for you, you have to apply for a loan through a financial institution, such as a local bank or a credit union, mortgage lender or online lender. Prior to applying, prepare yourself by doing the following:

• Calculate your approximate home equity.
• Decide how much you would like to borrow.
• Gather documentation on your current income and debts.
• Learn your current credit score.

Plan to compare rates and fees across multiple types of lenders, including banks, credit unions and mortgage companies.

Qualifying for a second mortgage

Qualifications tend to vary by mortgage lender, but applicants generally need the following to qualify for a second mortgage:

• Established home equity
• A credit score of at least 620
• A debt-to-income ratio of 43% or lower

Keep in mind that a second mortgage loan will usually only provide up to around 85% of the home value, minus what you owe on your primary mortgage, so you should have at least 15% equity in your home.

Your debt-to-income ratio (DTI) represents the percentage of your gross monthly income that goes toward regular debt expenses. To calculate this number, add up all your monthly debts, then divide the resulting figure by your gross monthly income.

Pros and cons of a second mortgage

A second mortgage isn’t for everyone. Homeowners should weigh the pros and cons of this type of loan before applying. For instance, interest rates on a second mortgage tend to be higher than those on a primary mortgage because the second mortgage lender is paid off second if the owner defaults and the home is sold.

Bottom line: Is a second mortgage a good idea?

Is a second mortgage right for you? A second mortgage tends to work best for those who are trying to fund a large, one-time expense, like paying off credit card debt or making a home renovation. The interest rate is higher than on a primary mortgage but lower than on a credit card or personal loan. Keep in mind you will have to pay closing costs and other fees, and you will be making a second monthly mortgage payment. If you decide a second mortgage is right for you, compare offers from multiple lenders — and let them know you’re shopping for the best deal.