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What Is A Second Mortgage Loan

    A loan for housing is called a mortgage, or, to be precise, the first mortgage. When most people buy a house or real estate, they get a home loan from a lender who uses the property as collateral. Because the loan is secured against your home (which is typically worth a large amount of money), you get access to more money than you would have had without using the house as collateral. Refinancing a home loan also involves taking out a loan, but in this case, the new loan replaces your existing mortgage.

    The loan has to be paid off first, then the borrower may take out another mortgage on their homes equity. When you take out a second mortgage, you are borrowing from the equity that has built up in your home–in other words, the difference between your homes value and the remaining balance on your first mortgage–your house as either a loan or as a line of credit. Because you are using equity in your first home to get a second mortgage, you need to have enough not just to get the second loan, but also to be able to leave about 20% of the home equity on a homeowners first mortgage. You could have the second mortgage for your primary home, then use your Home Equity Loan, or HELOC, funds for the down payment on your vacation home or for rental property.

    A second mortgage may even make sense if you are drowning in high-interest debt, and the home equity loan would allow you to lower your monthly payments (and interest costs) to manageable levels. Because the second mortgage is secured against your home, you can receive a lower interest rate than you would with a personal loan, which may help you repay your high-interest debt more quickly. A second loan, or mortgage, against your home would either be a home equity loan, which is a lump-sum loan with a fixed term and interest rate, or a HELOC, which has varying rates and continuous access to funds. The term second means if you are unable to make the mortgage payments anymore, and your home is sold to cover the debt, that loan is paid second.

    Home equity loans are typically used for one large-ticket item (a roof replacement or a large remodel) where the costs are known and fixed, and which could be completely covered by the amount of the loan. Known as 80-10-10 lending, the piggyback loan allows borrowers to avoid paying for mortgage insurance by pairing a second mortgage that covers 10% of a homes value with a first mortgage that covers 80% of a homes value. Cash-out refinancing is also a popular way of consolidating debts and financing home improvements, and does not require taking on a secondary loan (and thus making extra monthly payments) like a second mortgage. Lenders will probably encourage you to use a second mortgage for things with a longer-term or higher-value nature, like home improvements, debt consolidation, education expenses, and other big-ticket items, not just everyday, non-essential expenses.

    Buying a car, boat, or recreational vehicle Second mortgages are also commonly used as loans for home improvements, covering costs of large repairs (a new roof or HVAC system, for example), remodeling (a room addition, bathroom remodel, and similar), landscaping projects, or even the down payment for a second home. Many people use second mortgages for paying off student loans, credit cards, medical debt, or even for paying down part of a first mortgage. One benefit to using your second mortgage funds for home improvements is that, as part of the 2017 Tax Reform Act, interest paid on your second mortgage loan is deductible on your federal income taxes, but only when the loan is used for the purchase, construction, or substantial improvement of your home. Also, the interest can be tax-deductible if you use the second mortgage to buy, build or substantially improve the house that was used to qualify for the loan.

    You typically will pay closing costs of 2 percent to 5 percent of your second loan amount, and can use that money to buy or refinance your home. With piggyback loans, lenders typically will require that you finance at least 5 % to 10% of a homes purchase price with your own money; i.e., a 5-10% down payment. For example, in buying a $300,000 house, you could use your $240,000 main mortgage, $30,000 piggyback loan, and a $30,000 down payment to cover $300. Borrowers buying higher-value homes may borrow the Fannie/Freddie/FHA-limit conforming mortgage, and then finance the remainder using the piggyback loan and the down payment.

    If the value of your home is $300,000, but you are still $200,000 behind on the mortgage, you may be able to take out a home equity loan or take out a home equity line of credit up to $40,000 ($240,000=80% of $300,000). It depends on your lender, but you may be able to borrow up to 85 percent of the home value. You might typically be able to borrow up to 85 percent of the home is value, less any existing mortgage debt. You will probably also have to comply with a specific loan-to-value (LTV) ratio, which compares how much you are borrowing against the homes appraised value.

    Home equity loans typically come in larger amounts (the minimum loan size for many lenders starts at $10,000, and can reach $25,000), and you are typically required to pay the interest up front as mortgage points (2 percent to 5 percent of the loan value) during closing. A second piggyback mortgage may be issued concurrently with an initial home loan, and allows the homebuyer to borrow in order to reach the 20% threshold and avoid paying PMI. With increased cash flow, second mortgages are used to fund various expenses, as desired by the borrower, including home repairs, college tuition, medical expenses, and debt consolidation.

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