A junior mortgage is a mortgage loan that's subordinate to a primary or first mortgage. The junior mortgage is secured by the home, just like a first mortgage. A home equity loan and a home equity line of credit (HELOC) are two types of junior mortgages.
You may take out a second mortgage to tap your home's equity. Or it may be necessary to get a junior piggyback mortgage to avoid private mortgage insurance when purchasing a home. Before getting a junior loan, it's important to understand the financial considerations involved.
Definition and Examples of a Junior Mortgage
A junior mortgage is a second mortgage loan you take out against your home using the property as collateral. A junior mortgage assumes that you already have a mortgage that's also secured by the home.
For repayment purposes, junior mortgages take a backseat to first mortgages. So if you're unable to pay both loans and the home ends up in foreclosure, the first mortgage lender would take priority when receiving any proceeds from the sale of the home. Junior mortgages would be satisfied afterward if there are any remaining profits to be had. These types of mortgages can carry higher interest rates than first mortgages as they're generally riskier for the lender.
- Alternate definition: A junior mortgage can refer to a second mortgage loan, but it can also be used to describe a third or fourth loan secured using the home as collateral.
- Alternate name: Junior lien, second mortgage, piggyback mortgage
Home equity loans and HELOCs are common examples of junior mortgages. Both use the home as collateral and both allow you to tap into the equity that's accumulated in your home. Home equity loans are “closed-end” in that you're borrowing a set amount of money. Home equity lines of credit are “open-end,” as you can draw against your credit line as needed.
Just like with first mortgages, you'll need to meet the lender's credit score and income requirements to qualify for a junior mortgage loan.
How a Junior Mortgage Works
A junior mortgage can be used in one of two scenarios. One is to withdraw some of the equity in your home. This can involve taking out a home equity loan or a home equity line of credit.
With a home equity loan, you borrow a lump sum of money based on the amount of equity in the home. The money can be used to consolidate debts, pay for home repairs, or another purpose. Home equity loans typically have a fixed interest rate and set repayment terms, so your monthly payment is predictable. If you don't pay back a home equity loan, the second mortgage lender could pursue a foreclosure action against you.
A HELOC is an open-end credit line that you can draw against over time. This credit limit is based on the amount of equity you have in the home. But instead of getting a lump sum of money, you may be able to write checks or use a special credit card to withdraw money. HELOCs typically have variable interest rates, so your monthly payments may change as the interest rate adjusts.
If you're using a home equity loan or HELOC to consolidate credit cards or other debts, compare interest rates carefully to ensure that you'll save money.
A second purpose for junior mortgages is to avoid private mortgage insurance (PMI) when buying a home. Private mortgage insurance is generally required for conventional mortgage loans when putting less than 20% down. When using a junior mortgage this way, it's referred to as a "piggyback mortgage."
Here's how it works: Say you want to buy a home but you can only put 10% down on a conventional loan. Ordinarily, you'd finance 90% of the purchase and pay PMI on the loan. If your lender offers a piggyback mortgage option, you'd still put 10% down. But instead of one mortgage loan, you'd have two. The first would be for 80% of the purchase price, allowing you to sidestep PMI. You'd then have a second mortgage for 10% of the purchase price that piggybacks on the first.
Piggyback mortgages are not as common following the housing crisis of 2008. But if you're able to find a lender that offers one, you may be able to use a junior mortgage to avoid paying PMI.
Piggyback loans may have adjustable rates, which could negate some of your savings on PMI over time if the rate increases significantly.
Special Considerations for Junior Mortgages
A junior mortgage can be useful if you want to borrow against your home equity. For example, you might use a home equity loan or a HELOC to pay for a major kitchen renovation, cover outstanding medical bills, or consolidate high-interest debt. A junior mortgage could also save you money when purchasing a home if you're able to qualify for a low rate and avoid paying PMI on your first mortgage.
The main disadvantage of a junior mortgage, however, is that you're creating additional debt. If you're not able to make the monthly payments to either mortgage, this could increase the risk of defaulting on one or both loans. If the home ends up in foreclosure, you could lose the property along with all the money you've paid into both mortgages. For that reason, it's imperative that you do some budget calculations beforehand to ensure that having primary and junior mortgages at the same time is realistic and affordable.
Consider how having multiple mortgage loans may impact your credit score and what could happen to your score if you default. You must also think about how much you'll be able to borrow if you decide to take out a second mortgage. Lenders can limit the amount of equity you can withdraw when using a home equity line or HELOC. You can also be limited in how many junior mortgages you can hold at any given time.
- Secondary loans that use your home as collateral are called junior mortgages.
- Home equity loans and home equity lines of credit (HELOCs) are common examples of junior mortgages.
- You may use a junior mortgage when taking out a piggyback second mortgage to avoid paying private mortgage insurance on a first home loan.
- Junior mortgages take secondary priority for repayment when a borrower defaults and the home falls into foreclosure.