With a second mortgage, a homeowner can borrow at a very low interest rate, using his or her equity in the home as security.

You keep your existing first mortgage and add a second mortgage loan on top of it. In this way, you can tap into your home’s equity to make home improvements and accomplish other goals.

Many lenders offer low rates and flexible terms when getting a second mortgage.

Types of second mortgages

What is a home equity loan (HEL)?

A home equity loan is a lump-sum loan, usually with a fixed interest rate, that’s paid down over its term in equal installments. Rates are slightly higher than for variable home equity loans (discussed next) but you know your monthly payments will never rise.

What is a home equity line of credit (HELOC)?

A home equity line of credit functions like a line of credit. It differs from a home equity loan in three main respects:

1. You can borrow, repay and borrow again up to your credit limit during the initial “draw” period.
2. Later, there’s a repayment period during which you can’t borrow more and have to zero your balance. Normally you just pay it down. But you may be able to refinance.
3. You pay interest only on your outstanding balance.

Home equity lines of credit (HELOCs) are particularly good when you’re a contractor, freelancer or working in the gig economy. They let you smooth out differences in your monthly income.

And they can be handy if you need to borrow a large sum for a brief period because you’ll only be paying interest for that period.

Advantages of a second mortgage

So why take out a second mortgage in the first place? Let’s run through some advantages.

1. You can usually borrow more

Credit cards and personal loans usually let you borrow a few thousand dollars. But with a second mortgage you can typically borrow more — often much more.

Assuming your credit and finances are in good order, the only constraint is the amount of “equity” you have in your home. That’s the sum by which the market value of your home exceeds your current mortgage balance.

You won’t be able to borrow that full sum because lenders will likely want you to keep a cushion of roughly 20% of your home’s value.

For example, if your home’s worth $300,000 and your mortgage balance is $150,000. Your total equity would also be $150,000. You’d be able to leave 20% ($60,000) equity and still borrow $90,000 ($150,000 equity – $60,000 retained-equity cushion = $90,000).

2. Low interest rate

A second mortgage is typically quite secure for your lender. You’re using your home as collateral so the lender stands a very good chance of getting its money back. And that means it can afford to give you a lower rate than you’d generally get with unsecured loans such as credit cards or personal loans.

3. Any-purpose loans

Some loans restrict what you can spend your borrowed money on. For example, auto loans can only be used to buy a car or truck.

But you can spend the proceeds of a second mortgage on anything you want. Planning a weekend in Vegas where you’re happy to lose the whole lot on a single spin of the roulette wheel? That’s none of the lender’s business.

Though we wouldn’t recommend it.

4. Tax benefits

If you use the proceeds of a second mortgage to “buy, build or substantially improve your home” (IRS’s words), the mortgage interest may be deductible. That was the case for 2019 filings.

Using the money for any other purposes (including Vegas trips) will mean you can’t make those deductions.

But the tax code changes often and rules can get complicated. So talk to a qualified, professional advisor before you rely on your ability to make any deductions.

5. You don’t impact your first mortgage’s rate

This is an advantage that really applies only when mortgage rates are rising.

For example, imagine you got a loan at 2.5% and average rates were later up at 5%. A second mortgage would let you keep your low rate on your main borrowing and pay the high interest rate just on your new loan.

6. Closing costs are lower than for a refinance

Whatever current rates, your closing costs are likely to be lower with a second mortgage than if you refinance. It’s possible you could save thousands.

Use a refinance calculator to help you. Or talk to lenders about your options.

7. You may not need an appraisal

Some lenders say they require no “formal” appraisal on a second mortgage. But they’re likely to get one based on desk research of your neighborhood’s home-price trends and perhaps Google Street View.

Still, you might save that appraisal fee.

Disadvantages of a second mortgage

Inevitably, second mortgages come with cons as well as pros. Here are the main ones:

1. You’ll almost certainly pay a higher interest rate than on your first mortgage.
2. It’s an extra financial burden. A second mortgage on top of your primary mortgage means two payments each month instead of one.
3. You could lose your home to foreclosure. This is a secured loan with your home as collateral. As such, you give the lender the right to foreclose on the home to get its money back.

It’s also worth noting that (unsecured) personal loans have changed over the years. Some now compete more directly with second mortgages over rates, costs, and loan limits. But you’d need to be outstandingly creditworthy and have remarkably robust finances for the deals you’re offered to be comparable with a home equity loan.

Second mortgage rates

On the day this was written, the lowest home equity loan rate we found was 3.290% for a five-year term. But even advertised rates intended to tempt you went as high as 5.745%. Those were appreciably higher than the average 30-year fixed mortgage rate, which was 2.89% that day.

However, that lowest rate came with zero fees. And the highest charged only $99. Others, with rates in between, charged up to $1,354 in fees. They’re all thousands lower than you’d typically expect to pay in closing costs on a cash-out mortgage refinance (up to 2-5% of the loan amount).

HELOC rates were generally lower, with the best we found 2.240% with zero fees. But remember: HELOCs have variable rates. So you could pay more if interest rates rise.

HELOC rates are typically tied to wider rates: your lender’s prime rate plus a margin to take into account your risk of defaulting or paying down your debt early. When the prime rate moves, so does your rate.

At the time of this writing, prime rate was just 3.25%. So if your HELOC’s rate was prime + 0.50%, your rate today would be 3.75%. Ask yourself if you could afford the payments if prime went up to 5 or 6%.

Home equity loan rates, though, are typically tied to mortgage rates. They’re usually fixed but you may be able to find variable-rate options.

How to get a second mortgage

Applying for a home equity loan or HELOC is fairly straightforward. It’s like accessing any other borrowing and, typically, they are widely available.

However, if you’re reading this while the COVID-19 pandemic is still a major problem, you may find that some lenders have suspended their second mortgage offerings, especially on HELOCs.

Before you apply, make sure you’re in good financial shape: that you are the sort of borrower lenders find attractive.

Reasons to get a second mortgage

Anyone who needs a cash injection may be interested in a second mortgage. But here are some circumstances in which many find them especially attractive:

1. Debt consolidation. Pay down store and credit cards, personal loans and perhaps even auto loans. You can make a single, much smaller payment at a considerably lower interest rate.
2. Manage irregular cash flow. HELOCs let those in the gig economy smooth out the peaks and troughs in their irregular incomes. Borrow, repay and borrow again as needed.
3. When a cash-out refinance is undesirable or impossible. You may not want to refinance your existing mortgage. Or you may not qualify for a new one.
4. Pay for home improvements. There may be tax advantages.

80/10/10 Piggyback Loans

There’s another situation in which home equity loans can be useful. Suppose you have a 10% down payment for your first or next home. You’ll likely have to pay expensive mortgage insurance. But if you use a second mortgage to borrow the amount you need to put down 20%, you won’t have that obligation.

This is more common than you may think. In the jargon of the mortgage industry, it’s called “piggybacking.” But you must make sure you can comfortably afford both mortgage payments.

How to qualify for a second mortgage?

Lenders are going to assess that you’re able, ready and willing to make payments on your new loan — just as they do for first mortgages. In particular, they’re going to look at your:

1. Credit score and report. If you’ve managed debt well in the past, you’re likely to do so in the future. Expect to need good credit (a score of 670-739 or higher, according to FICO).
2. Equity. As discussed above, you’ll probably need to retain roughly 20% of the equity you have in your home. So you can often borrow the difference between 80% of your home’s market value and your current mortgage balance. But don’t take more than you need.
3. Employment record. You need a job and a record of being a consistent earner.
4. Existing debts. The lender wants to know you can afford to make payments on both mortgages. And the amount you’re paying to keep up with other monthly obligations (existing debts, child maintenance, alimony, other homeownership costs) will affect its view of that affordability.

Of course, you should tell your lender if you’re going to use your second mortgage to consolidate some or all of your existing debts. That could change that last calculation.

FAQ

Are mortgage rates higher for a second mortgage than a first mortgage?

Generally yes. Though not always much higher. The difference will depend on how attractive a borrower you are.

What’s the difference between a second mortgage and a refinance?

For many borrowers, the important differences are that it’s easier and cheaper to get a second mortgage. But expect to pay a higher interest rate.

If you’re torn between a cash-out refinance and a second mortgage, run the numbers. There’s a mathematical answer that should tell you which is more beneficial to you. But don’t be surprised if your personal circumstances and priorities override that math.

How do you get a second mortgage?

1. Search for lenders online.
2. Apply online or over the phone. Get a rate quote.
3. Supply documentation requested by the second mortgage lender.
4. Wait for the lender’s approval decision.
5. If approved, supply any additional documentation.
6. Sign final paperwork.
7. Receive funds.

Just as with a first mortgage, make sure your credit and finances are in the best shape possible before you apply. That should earn you a lower rate and might even be the difference between your application being approved or declined.

What lenders offer second mortgages?

Large numbers of banks, mortgage lenders, and credit unions offer home equity loans and HELOCs. You don’t have to go for the lender with which you have your first mortgage.

Indeed, you shouldn’t. By all means, get a quote from it. But shop around for the best deal and get quotes from multiple lenders. This comparison shopping can save you a large amount of money.

These loans can enable you to convert your real estate equity to cash.