What Exactly is a Second Mortgage?

Typically, a second mortgage is defined as a secured loan that is subordinate to a first mortgage on the same property. The borrower can generally use the proceeds from a second mortgage for any purpose. Currently, a popular use of second mortgages is to pay off high-interest consumer debt, such as credit cards and car loans. Other common uses are for home improvements, college tuition, or to take a vacation. Second mortgages can even be used to secure lines of credit for future needs.

In the past, the total amount of debt from a first and second mortgage combined could not be more than 80% of the home's appraised value. Recently however, low interest rates and a hyper-competitive marketplace created a lending environment where some lenders were approving second mortgages that, when combined with the first mortgage balance, totaled as high as 125% of the home's appraised value.

Most financial advisors will warn you that carrying that much debt on your home is never a good idea. In my practice, I never recommend borrowing more than 100% of the value of your home and would rarely recommend a second mortgage with a loan to value of greater than 90%.

Because a second mortgage is a property lien that is placed behind the first mortgage, this means that in the event of a default, after the property is sold the first mortgage gets paid first, including any legal costs and other costs of the sale, before the second mortgage can be paid. If there is not enough money from the sale of the home, the second mortgage does not get paid.

Why A Higher Interest Rate?

When determining the interest rate that a lender is willing to loan money out for a home mortgage, he looks at the risk level to him for loaning that money. This is the reason that a high risk borrower with a poor credit history gets charged a higher interest rate than a low risk borrower with a strong credit history.

The same theory holds true with a second mortgage. Because the lender of the second mortgage is second to be paid off in the event of a default, and because there is a greater chance that there might not be enough equity in the home to pay off the second mortgage in full, second mortgages are usually given at a higher interest rate than are first mortgages; irregardless of who the borrower is.

2nd Mortgage Terms

Although you will have choices for terms when selecting your second mortgage, in general the terms given for them are shorter than those of a first mortgage. This is primarily because the amount of the second mortgage is generally much lower than that of the first mortgage.

Repayment terms for second mortgages can vary considerably, so it is important to look around for the one that is best for you. Mostly they range in length from 5 to 20 years, with the majority of the loans being 10 to 15 years. Some lenders may offer a 30 year amortization with a balloon (maturity date) of 15 years. This type of loan is referred to as 30 due in 15. Generally, the longer the maturity, the higher the interest rate. Conversley, the higher the credit score, the lower the interest rate.

Types of Second Mortgages

Just as the length of the second mortgage can vary, so can other repayment terms. The majority of second mortgages are paid back in equal monthly payments with a portion of the payment going to interest and a portion to the principal balance, just like a first mortgage.

Second mortgages come in two basic types, fixed rate and home equity line of credit (HELOC). Fixed rate mortgages are the standard offering. The HELOC mortgage is a little unique and has been very popular of late. Typically this loan calls for interest only payments for the first 5 to 10 years with the line of credit frozen at the outstanding balance of the loan. The loan payments are recast at that point and a standard principal and interest payment schedule is established for the remaining 10 to 20 years. HELOC's are typically priced with a variable interest rate indexed to the New York City prime interest rate.

As with other loan pricing, the lower the FICO score and the higher the loan to value, the higher the interest rate for HELOC type mortgages.

When considering a second home mortgage, be sure to shop around and then talk to lenders to ensure that you get the best deal for you!

About the Author

Mike Cotter has been a professional lender for over 30 years. He began his career in the commercial banking industry in 1976 and in 1982 opened his own commercial bank and served as President and CEO for 10 years. He has been a successful mortgage broker for over 16 years and owns his own company.