What Is a Second Mortgage?
A second mortgage is a loan that uses your home as collateral, similar to a loan you might have used to purchase your home. The loan is known as a “second” mortgage because your purchase loan is typically the first loan that is secured by a lien on your home.
Second mortgages tap into the equity in your home, which is the market value of your home relative to any loan balances. Equity can increase or decrease, but ideally, it only grows over time. Equity can change in a variety of ways:
- When you make monthly payments on your loan, you reduce your loan balance, which increases your equity.
- If your home gains value because of a strong real estate market—or improvements you make to the home—your equity increases.
- You lose equity when your home loses value or you borrow against your home.
Second mortgages can come in several different forms.
Lump sum: A standard second mortgage is a one-time loan that provides a lump sum of money you can use for whatever you want. With that type of loan, you’ll repay the loan gradually over time, often with fixed monthly payments. With each payment, you pay a portion of the interest costs and a portion of your loan balance (this process is called amortization).
Line of credit: It’s also possible to borrow using a line of credit, or a pool of money that you can draw from. With that type of loan, you’re never required to take any money—but you have the option to do so if you want to. Your lender sets a maximum borrowing limit, and you can continue borrowing (multiple times) until you reach that maximum limit. As with a credit card, you can repay and borrow over and over.
Rate choices: Depending on the type of loan you use and your preferences, your loan might come with a fixed interest rate that helps you plan your payments for years to come. Variable rate loans are also available and are the norm for lines of credit.
Advantages of Second Mortgages
Loan amount: Second mortgages allow you to borrow significant amounts. Because the loan is secured by your home (which is usually worth a lot of money), you have access to more than you could get without using your home as collateral. How much can you borrow? It depends on your lender, but you might expect to borrow up to 90% of your home’s value. That maximum would count all of your home loans, including first and second mortgages.
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. Unlike unsecured personal loans such as credit cards, second mortgage interest rates are commonly in the single digits.
Tax benefits (especially Pre-2018): In some cases, you’ll get a deduction for interest paid on a second mortgage. There are numerous technicalities to be aware of, so ask your tax preparer before you start taking deductions. For more information, learn about the mortgage interest deduction. For tax years after 2017, the Tax Cuts and Jobs Act eliminates the deduction unless you use the money for “substantial improvements” to a home.
Interest costs: Any time you borrow, you’re paying interest. Second mortgage rates are typically lower than credit card interest rates, but they’re often slightly higher than your first loan’s rate. Second mortgage lenders take more risk than the lender who made your first loan.
Common Uses of Second Mortgages
Choose wisely how you use funds from your loan. It’s best to put that money toward something that will improve your net worth (or your home’s value) in the future. You’ll need to repay these loans, they’re risky, and they cost a lot of money.
- Home improvements are a common choice because the assumption is that you’ll repay the loan when you sell your home with a higher sales price.
- Avoiding private mortgage insurance (PMI) might be possible with a combination of loans. For example, an 80/20 strategy or “piggyback” loan uses a second mortgage to keep your loan-to-value ratio above 80 percent on your first loan. Just make sure it makes sense compared to paying—and then canceling—PMI.
- Debt consolidation: You can often get a lower rate with a second mortgage, but you might be switching from unsecured loans to a loan that could cost you your house.
- Education: You may be able to set yourself up for a higher income. But as with other situations, you’re creating a situation where you could face foreclosure. See if standard student loans are a better option.
- CRA: paying off taxes