Taking out a second mortgage allows you to borrow against the equity you’ve built up in your house. You can use the lump sum you receive from your second mortgage for whatever you wish. You can fund tangible projects like home improvements, pay off higher-interest debt such as credit cards or student loans, or finance a dream vacation. In short, second mortgages give you nearly limitless options regarding what you can do to take advantage of the money you’ve invested in your home.
There are plenty of situations where a second mortgage may make sense, but there are also a few alternatives that we’ll discuss as well, like refinancing. Although applying for a second mortgage may feel similar to the process involved with obtaining a primary mortgage, there are a few nuances that make a second mortgage application a bit more complex. Keep reading to learn the information that you need to prepare for applying for a second mortgage.
What is a Second Mortgage?
A second mortgage is a loan that you take out against the equity that you’ve already built in your home. To understand where second mortgages come into play, you have to understand the concept of equity. If you’ve been paying off your mortgage for a while, then you’ve built equity with each payment that you’ve made towards the principal loan amount. Unfortunately, the amount that you pay in interest each month doesn’t build equity.
If you own a house that is valued at $250,000 and you still owe $150,000 on the principal loan to your lender, then you’ve built $100,000 in equity in your home. For simplicity, the $100,00 is the part of your home that you own and the part you can borrow against when you get a second mortgage.
Second mortgages tend to be riskier for lenders because they will only be paid after your primary lender has been satisfied if you default. Consequently, second mortgages often have higher interest rates than primary mortgages.
There are two primary types of second mortgages: home equity loans and home equity lines of credit (HELOCs). Depending on your situation, as well as what you intend to use the money from your second mortgage for, you may prefer one over the other. Here’s a description of both types of loans.
Home Equity Loans
When you secure a home equity loan, your lender will give you a lump sum of cash based on your equity. You can’t get 100% of your equity, but some lenders will loan you up to 90% of the equity that you have in your home. Home equity loans come with a fixed interest rate, so you’ll pay the same amount each month to repay your lender. Loan terms are between 5-30 years.
Home Equity Line of Credit (HELOC)
A Home Equity Line of Credit (HELOC) is a revolving line of credit that you’re granted based on your home’s equity. It gives you the flexibility to draw down your credit line based on your needs, repay, and borrow again. Unlike the home equity loan, you will not have a fixed monthly payment as the amount you borrow fluctuates based on how much of the line you use. Once the time frame of your HELOC is over, you must pay off your account, or the lender will come after your home.
HELOCs offer great flexibility, but you must exercise caution and discipline in using them.
What are the Requirements for a Second Mortgage?
You’ll need similar paperwork to apply for a primary mortgage loan, but with a few additions. The main second mortgage requirements are that you have equity in your home, and more of it increases your chances of securing a second mortgage. Lenders also want to know that you have good credit (at least a 620 credit score, often higher) and that you’re not carrying a lot of additional debt (a debt-to-income ratio below 43%).
When you apply, have the following pieces of information available:
- Credit report
- Copy of the deed to your property
- Recent tax appraisal
- W-2’s and tax returns for the past two years along with a current pay stub. If you’re self-employed, be prepared to provide tax returns from the last two years, including all schedules.
- Proof of income from all sources including alimony, child support, disability payments, lawsuit settlements, inheritance, etc.
- Copies of your last 3-6 bank statements
- Information about all of your open credit accounts (account numbers, payments, and outstanding balances)
- Current mortgage statement
- Homeowner’s insurance information
Choosing Between a Second Mortgage or Refinancing
A popular alternative to obtaining a second mortgage is refinancing your first mortgage. When you refinance your first mortgage, you essentially renegotiate the terms of your original home loan. If a lender refinances your original loan, they’ll use your home as collateral, but lenders providing a second mortgage don’t have that same security.
Homeowners interested in a second mortgage may also consider a cash-out refinance. This allows them to access a lump sum of cash based on their home equity in exchange for a new, higher principal loan balance. Instead of taking on a second monthly payment, homeowners can modify their current loan terms and monthly payment.
Consistent payments towards your second mortgage and good credit will also give homeowners the chance to secure second mortgage refinancing. That refinancing process may yield lower interest rates or the chance to consolidate multiple mortgage payments into a single loan.
What are the Advantages of a Second Mortgage?
There are three primary advantages to securing a second mortgage.
- High loan amounts. With a second mortgage, you’re often allowed to borrow more money than other types of loans. This can be especially helpful if you’ve been making payments on your loan for a long time. Some lenders will allow you to borrow up to 90% of your home’s equity when you take out a second mortgage.
- Lower interest rate than other types of credit. Since second mortgages are considered a kind of secured debt (your home ultimately serves as the collateral for the loan), you’ll pay a relatively low-interest rate. Some people choose to use the funds from their second mortgage to pay off credit cards or student loans that typically have higher interest rates. However, keep in mind that second mortgages often come with higher interest rates than primary mortgages because the secondary lender’s position is less secure than the primary lender’s place.
- Use the funds however you want to. Unlike other loans, like auto loans or student loans, you’re not restricted in how you use the loan proceeds. Renovate your house, buy stocks, gold, or cryptocurrency, or do whatever you’d like.
Tips for Applying for a Second Mortgage
- Compare all of your options, including refinancing, to ensure that applying for a second mortgage is your best option.
- Let your lender know what you’d like to do with the money from your second mortgage. Your answer can boost your case.
- Check your credit report before you apply. As with a primary mortgage, the better your credit score, the lower your interest rate will likely be.
- Shop around. Compare lenders and home equity loan options to find the best solution based on your current situation. Keep an eye on the best interest rates, too.
- Fax or email the documentation to your lender to save time.
- When you apply, complete the application thoroughly so that you can get approved and close as soon as possible.
- Beware of the potential for bad loans. If your lender encourages you to falsify elements of your application to get the loan, borrow more than you need, or take on a monthly payment that you can’t realistically handle, run fast and far. Similarly, if your lender shows up at closing with a different loan product than you’ve agreed to, asks you to sign blank forms, or refuses to provide you copies of documents that you’ve signed, you might find yourself heading for trouble.
- If a particular lender has rejected your second mortgage application, ask them why. This information can help your future chances at approval. It can often be something simple, like paying down some credit cards that can increase your credit score just enough to help you qualify.
Contact A and N Mortgage
Applying for a second mortgage is one option for accessing the equity that you have built-in your home. A home equity loan gives you access to a lump sum of cash, and a HELOC provides you with a line of credit, sometimes up to 90% of the value of the equity in your home. With those funds, people often pay off debt with higher interest rates, like credit cards or student loans, or pay for big purchases, like a home renovation.
Second mortgages are secured by your home, but secondary lenders will only be satisfied after the initial lender in the event of default. Depending on your situation, refinancing your primary mortgage, possibly with a cash-out refinance, might be preferable to a second mortgage, so be sure to consider all of your options. If you’re still wondering whether or not a second mortgage is the right decision for you, contact A and N Mortgage to speak with a knowledgeable mortgage consultant!
A and N Mortgage Services Inc, a mortgage broker in Chicago, IL provides you with high-quality home loan programs, including FHA home loans, tailored to fit your unique situation with some of the most competitive rates in the nation. Whether you are a first-time homebuyer, relocating to a new job, or buying an investment property, our expert team will help you use your new mortgage as a smart financial tool.