How Do We Get a Second Mortgage?
You Will Need Equity in Your Home to Take Out a SecondMortgage
Question: How and where do we get a second mortgage?
A reader asks: "My wife and I were initially thinking about buying a bigger home. My father-in-law suggested we get a second mortgage and add a second floor to our existing home. But I've heard banks don't make second mortgages anymore. How do we get a second mortgage? What does getting a second mortgage entail?"
Answer: Prior to the boon years of the late 1990s and early 2000s, almost anybody could get a second mortgage. Many homebuyers obtained second mortgages to help them buy homes. Typically these were piggyback loans, consisting of an 80 percent first mortgage and a 20 percent second mortgage. Which means 100% financing.
Those types of loans are few and far between today. But it doesn't mean a homeowner can't get a second mortgage. However, most lenders want to see that a home has equity before they'll consider approving a homeowner for a second mortgage. Before the housing market crash of 2008, a borrower could get a second mortgage up to 100 percent of the home's market value, and sometimes for more than that. Today, banks want tangible security, appraised and backed by solid equity, for such loans.
What Is a Second Mortgage?
A second mortgage is junior in position to an existing first mortgage. Instead of refinancing a first mortgage by replacing it with a higher mortgage, a borrower may prefer to take out a smaller second mortgage. When your costs to obtain the second mortgage are based on the amount borrowed, the costs associated with the loan are less.
Note that a second mortgage could also be a larger mortgage than an existing first mortgage. There is no requirement that the new second loan amount be smaller than the first. Many consumers base the size of their second mortgage on interest rate and payment amount. A smaller mortgage also means lower closing costs, which is always welcome.
To better clarify, let's look at a sample second mortgage.
Say your home is worth $200,000. You owe $120,000 on your first mortgage. A bank might use the 80-percent rule to finance 80 percent of $200,000, or $160,000, if your credit scores are good enough.
After subtracting your first mortgage of $120,000, you may be able to borrow $40,000 on a second mortgage while still maintaining a safety cushion of 20% equity. The second mortgage is then recorded in the public records and becomes a lien against your home. If you don't make the payments, a lien gives the bank a legal right to seize your home in foreclosure.
Reasons to Get a Second Mortgage
The interest rate and repayment schedule may be more favorable on a second mortgage than refinancing your existing first mortgage into a larger loan. For example, if your $120,000 mortgage is payable at 6.5 percent interest, a second mortgage might be available at a lower rate, perhaps 5 percent or less, depending on market fluctuations.
Moreover, the cost to obtain a $40,000 loan may be very small compared to the cost to obtain a $160,000 loan. Some second mortgages do not cost the borrower any upfront money at all -- there may be no closing costs. For example, most closing costs run about 3% of the mortgage. Three percent of $40,000 is only $1,200, compared to three percent of $160,000, which is $4,800.
What Can You Do With the Money From a Second Mortgage?
A lender will ask why you want a second mortgage on your loan application. You might think it's none of the lender's business, but the lenders don't agree with you. Here are reasons a lender might consider:
- Home remodeling or additions
- Home improvements
- Emergency medical
- Reliable investments
- Care for dependents
- Debt consolidation, if it makes sense
- Bail bond security
Lenders prefer not to extend loans for depreciating assets. Ask your lender about special requirements for spending the proceeds before applying for a second mortgage.
Also keep in mind that the Tax Cuts and Jobs Act of 2017 still allows for an interest deduction on a second mortgage provided the loan proceeds were used to buy, build or improve a home.
At the time of writing, Elizabeth Weintraub, CalBRE #00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.