What is a second mortgage and how does it work?

Not all mortgages are the same — nor do they have the same uses. Some can help you buy a home or refinance your old loan, while others can be used to cover home repairs, pay off debts, or even provide cash in a pinch.

Second mortgages fall into the latter category and are an option for existing home owners. They’ve been especially popular in recent months as US homeowners rush to tap $29.6 trillion in home equity — a record high.

Do you have home improvements to pay for or need funds for medical bills, college tuition, debts or other expenses you’re facing? Here’s what you need to know about second mortgages — and how they can help.

What is a second mortgage?

Second mortgages allow you to borrow against the equity you have in your home — or the portion of the home’s value you actually own. For example, if your home was worth $500,000 and your current mortgage loan had $400,000 on it, you’d have $100,000 in equity. A second mortgage would let you borrow a portion of that equity and pay it back — plus interest.

“A second mortgage is when you take out a loan against the equity in your home after you have already taken out traditional financing,” says Alexander Suslov, head of capital markets at A&D Mortgage. “This means that instead of taking out one large loan for the purchase price of your home, you take out two loans — one for the purchase price and then another for additional funds or to refinance existing debt. In this sense, it works like any other type of loan: You borrow money from the lender and then pay it back with interest over time.”

A second mortgage is called such because it comes secondary to another mortgage. This means that if you were to foreclose on your home, the lender on your first mortgage would have the right to sell the property and pay off the remaining balance first. The lender on your second mortgage would come after that, using any remaining money to pay off the debt.

How to say a second mortgage works?

With a second mortgage, you borrow against your home equity. While lenders usually won’t let you borrow all of the equity you own, most allow you to tape 80 to 90% of it — minus your existing mortgage balance.

“The amount you can borrow with a second mortgage depends on your home’s value and your credit score,” says Adam Spigelman, vice president at Planet Home Lending. “This percentage includes the combined amount of both your first and second mortgages. The higher your credit score, the more you can typically borrow.”

So, in that previous example, if your home was worth $500,000, you could potentially borrow up to $50,000 (90% of $500,000, minus your mortgage balance of $400,000).

“Second mortgages can give you access to the equity in your home without having to touch your first mortgage,” says Scott Bridges, senior managing director of consumer direct lending at Pennymac. “Depending on your financial needs, second mortgages can be provided in lump sums or similar to a credit line where you can spend and repay over time.”

Second mortgages usually last between five and 30 years. Depending on what type of second mortgage you get (more on this below), you may pay a fixed payment every month or that payment may fluctuate over time.

Types of second mortgages

Home equity loans and home equity lines of credit (HELOCs) are the two main forms of second mortgages. As their names suggest, these both allow you to borrow from your home equity, but the way you access the money — and pay it back — varies.

Home equity loans are much like other loans you would apply for. Once you’re approved, you’ll get a lump sum payment and can use the money as you wish. You’ll then pay it back monthly — usually with a fixed interest rate and payment — for a set amount of years.

HELOCs, on the other hand, are more similar to credit cards. With these, you get a line of credit that lets you access your equity. You can then make withdrawals from that line of credit as needed during the “draw period,” which usually lasts about 10 years.

Typically, you’ll only make interest payments in the draw period. When that period ends and you enter the “repayment period,” you’ll start paying back the money you withdrew.

One thing to note about HELOCs: They typically have a variable interest rate, so it can rise or fall during the life of the loan.

Requirements for a second mortgage

Second mortgages can often be harder to qualify for than first mortgages since they’re an added risk to the lender (there’s no guarantee they’ll get paid back if you default on the loan). You’ll usually need at least a 620 credit score (sometimes higher) and at least 10 to 20% equity in your property.

“Typically, second mortgage requirements can be stricter than traditional mortgages in terms of credit requirements because they can be considered a higher risk for lenders,” says Vikram Gupta, head of home equity at PNC Bank. “They are often priced higher than first mortgages too.”

By “priced higher,” Gupta means they come with higher interest rates than traditional mortgages. Despite this, they’re usually still lower than the rates you’ll see on other financial products — like credit cards, for example. This is why home equity loans and HELOCs are often good choices for paying off other debts.

“We see many of our customers pursue a second mortgage to consolidate high interest rate credit card debt or do home improvements,” says Bridges.

Is a second mortgage right for you?

Second mortgages can be helpful tools, but they’re not right for everyone. As mentioned above, they can be a smart way to pay off higher-interest debts, but if you go this route, make sure the savings outweigh any closing costs the loan may come with. You’ll also want to be confident that you can pay off the loan, since you’ll be using your home as collateral.

A second mortgage can also be a good choice if you need cash but don’t want to use a cash-out refinance, which would mean replacing your current mortgage loan with a new, higher-rate one.

“From a financial planning standpoint, a second mortgage is a good idea when the homeowner has a significantly lower rate on their first mortgage than the current market,” Bridges says. “Imagine you have a 3% first mortgage and need $100,000 to consolidate debt or do home improvements. Right now it’s typically smarter for homeowners to utilize the second mortgage to tap into their equity instead of refinancing their entire loan balance to today’s 6 to 7% rate range.”

Finally, you might also consider a second mortgage if you’re looking to repair or improve your home. Not only can this help you spread the costs of the improvements out, but it can also increase your home’s value and, in some cases, even qualify you for an extra tax deduction.

How to get the best rates

As with any mortgage, shopping around is key if you want the lowest second mortgage rates. To do this, get quotes from several lenders and banks, and compare each company’s fees.

“Different lenders offer different rates and terms,” Suslov says. “So it’s important to determine which ones will work best for you based on your individual financial situation.”

Boosting your credit score can also help, as can having a large equity stake, as both of these reduce the risk the lender takes on with your loan.

As Bridges puts it, “The way to get the best rate on a second mortgage is simply to have a strong credit score, a low debt-to-income ratio, and equity in the home after the second mortgage is acquired.”

Editorial Disclosure: All articles are prepared by editorial staff and contributors. Opinions expressed therein are solely those of the editorial team and have not been reviewed or approved by any advertiser. The information, including rates and fees, presented in this article is accurate as of the date of the publication. Check the lender’s website for the most current information.

this article was originally published on SFGate.com and reviewed by Lauren Williamson, who serves as Financial and Home Services Editor for the Hearst E-Commerce team. Email her at [email protected].