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A second mortgage is a lien on a property which is subordinate to a more senior mortgage or loan. Called lien holders positioning, the second mortgage falls behind the first mortgage. This means second mortgages are riskier for lenders and thus generally come with a higher interest rate than first mortgages. This is because if the loan goes into default, the first mortgage gets paid off first before the second mortgage. Commercial loans can have multiple loans as long as the equity supports it.
When refinancing, if the homeowner wants to refinance the first mortgage and keep the second mortgage, the homeowner has to request a subordination from the second lender to let the new first lender step into the first lien holder position.
A second mortgage can be structured as a fixed amount to be paid off in a specific time, called home equity term. They can also be structured like a credit card giving the borrower the option to make a payment less than the interest charged each month.
Due to lender guidelines, it is rare for conventional loans for a property having a third or fourth mortgage.
In terms of foreclosure, a second lien holder can start the foreclosure process when a homeowner stops making payments. The second lien holder has to satisfy the first mortgage balance before they could collect on the second mortgage balance.
In situations when a property is lost to foreclosure and there is little or no equity, the first lien holder has the option to request a settlement for less with the second lien holder to release the second mortgage from the title. Once the second lien holder releases themselves from the title, they can come after the homeowner in civil court to pursue a judgement. At this point, the only option available to the homeowner is to accept the judgment or file bankruptcy.
Generally, when considering the application for a second mortgage, lenders will look for the following:
- Significant equity in the first mortgage
- Low debt-to-income ratio
- High credit score
- Solid employment history
Second mortgage types
A second mortgage comes in many forms, with each type using a home as collateral. Second mortgages are possible because of the equity in the home, which can accumulate by making a down payment at the time of purchase, through monthly payments, and/or through market value increases.
Also known as a one-time loan and home equity loan, the borrower receives a lump sum of money from the lender. With this type of loan, the borrower is required to repay the loan by making fixed monthly payments. Each payment consists of a portion of the loan balance, along with interest costs. This is similar to a first mortgage.
Line of credit
A home equity line of credit is another type of second mortgage, with this in the form of a predetermined amount of money for the borrower to draw from. With this type of loan, the borrower is not required to take any of the money, but they have the right to do so based on their personal requirements. With a line of credit, the lender sets a maximum borrowing limit, which may be increased at the borrower’s request. The borrower is able to borrow and repay the line of credit as many times as they wish.
A second mortgage can be used for many expenses, at the discretion of the borrower. Some of the most common uses of this loan include:
- Home renovations
- College tuition
- Medical expenses
- Debt consolidation
Lenders may request information on what the money is to be used for, but borrowers have the option to make their own decisions after securing the funds.
There are tax benefits of a second mortgage, such as a deduction for any interest paid on the loan. These are not guaranteed and are based on the tax situation of the borrower.
Risk of foreclosure
A second mortgage, just the same as a first mortgage, uses the home as collateral. With this, when a borrower fails to make payments, the lender has the right to foreclose on the property.
In much the same manner as a purchase loan, there are costs associated with a second mortgage. These vary based on many factors, including the lender and the amount of money being borrowed.
- Credit checks
- Origination fees
No closing cost
Many lenders provide no closing cost second mortgages, meaning that the borrower is not required to bring any money to the closing table. With this, the closing costs are instead rolled into the cost of the loan, meaning that the borrower pays the money in another way.
Obtaining a second mortgage is similar to purchasing a home, with the lender requiring a variety of information and documentation to make a decision on the application:
- Pay stubs
- Tax returns
- Bank statements
- Completed loan application
- Bad Lending Practices
Second mortgages often present potential problems that are not typical with a conventional home purchase.
- Balloon payments
- Voluntary insurance
- Prepayment penalties