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A second mortgage is basically a loan that you take against the equity that you have already built into your home. The proceeds from the second mortgage can generally be used for whatever purpose the borrower has in mind. It can be used to pay off a car loan or credit cards. The proceeds can be used for home improvement or to take a vacation. The money can even be put in a savings account for a rainy day fund.

Historically, the total amount of debt from the first and second mortgage combined could not be more than 80% of the total market value of the home. However, low interest rates and a competitive marketplace have created a lending environment where some lenders are approving second mortgages that, when combined with first mortgage balance, is totaling as high as 125% of the home 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%.

A second mortgage is always subordinate to the first mortgage. This means that in the event of a default, the property is sold and the proceeds are used to pay the first mortgage first, including any legal costs and other costs of the sale. The remaining proceeds are applied to the second mortgage. If there is not enough money remaining from the sale of the home, the second mortgage does not get paid.

A Higher Interest Rate for Second Mortgages

The interest rate that a lender is willing to loan money out at for a home mortgage is dependent on the risk level to him. For this reason that a high risk borrower with a poor credit history will always be charged a higher interest rate than a low risk borrower with a strong credit history.

This theory also holds true for a second mortgage. Because a second mortgage lender is (by definition) second in position to be paid off in the event of a default, and because there is a greater chance that in default there may not be enough equity in the home to pay off the second mortgage in full, second mortgages are almost always given at a higher interest rate regardless of who the borrower is.

2nd Mortgage Terms

Even though you may be offered several options for terms for your second mortgage, the terms offered will most likely be shorter than those of a first mortgage. This is primarily due to the fact that 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.

Second Mortgages Types

Not only can the length of the second mortgage vary, so can other repayment terms. The majority of second mortgages, however, 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.

The two most common types of second mortgages are the fixed rate and the home equity line of credit (HELOC). The former is a standard offering. The home equity line of credit is a little unique and has been very popular. The loan typically calls for interest only payments for the first 5 to 10 years and then the line of credit is frozen at the outstanding balance of the loan. At that point, the loan payments are recast and a standard principal and interest payment is established for the remaining 10 to 20 years. The HELOC’s are typically priced with a variable interest rate that is most commonly 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 contemplating a second mortgage, do your homework, shop around and then talk to lenders to ensure that you are getting the best deal!

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