Last updated: February 27, 2024

Mortgage Products

What is a second mortgage? How does it work?

Family in living room laughing while they discuss what a second mortgage is as well as the benefits risks and other options.

When you purchase a home, you’re likely to make a down payment and engage with a mortgage lender to borrow the rest of the purchase price of the home.

This loan is known as a mortgage, but it is sometimes called a first home mortgage or purchase mortgage to distinguish it from a second home mortgage.

Your mortgage is secured by using your home itself as collateral — meaning that if you stop making payments before the loan is completely paid off, you make risk foreclosure. However, because a mortgage is backed by collateral, that means they will typically come with lower interest rates than unsecured borrowing options.

What is a second mortgage?

After you have built enough equity in your home, you may be able to take out a second mortgage as an additional secured loan that uses your home as collateral.

Second mortgages may be a great way of using the equity in your house to free up cash for important needs. While the new loan increases your outstanding mortgage debt, it gives you cash that you can use for debt consolidation, home improvement, or other major expenses.

Because a second mortgage is tied to the equity you have in your home it is often called a home equity loan.

How to use a second mortgage

When you take out a second mortgage, you have ultimate freedom in deciding what to do with it. However, financial advisors may recommend that you use this money for items that have lasting value, such as financing home improvement or renovations, consolidating high-interest or variable-rate debts, or funding major expenses. Funds from a fixed rate home equity loan are typically disbursed into your account as a lump sum.

Borrowers are cautioned to avoid using second mortgages for everyday expenses without having a clear plan to reduce spending and prevent building additional debt.

Mortgage options

Here are the key differences between a home equity loan, home equity line of credit (HELOC), and mortgage refinance:

A home equity loan or a second mortgage is a fixed-amount, fixed-term loan at a fixed rate. After your loan is approved you get a lump sum payout and then begin making monthly payments of interest and principal.
A home equity line of credit (or HELOC) is an open-ended loan that allows you to borrow money when you need it, possibly multiple times, up to your approved credit limit. Once you start making withdrawals, you start making monthly payments toward interest and principal.
Mortgage refinancing is a third option if mortgage interest rates have declined significantly from the time of your original purchase or last refinance. This involves replacing your existing mortgage with a new one that typically has an updated interest rate and/or term length resulting in a new monthly payment amount.

The pros and cons of a second mortgage

Here are some of the benefits and pitfalls of second mortgages to consider before taking one out.

Pros

Available Cash: When you need money, you can get a lump sum from a second mortgage or have a source of credit from a HELOC.
Ease of qualification: Because the loan is secured by your home, it may be easier to qualify for a second mortgage than for other unsecured loans, such as personal loans.
Lower interest rates: While a second mortgage is likely to have a higher interest rate than your first mortgage, it is likely to be lower than other alternatives such as personal loans and other unsecured loans.
Possible tax savings: Depending upon how you are using the loan, interest paid on a second mortgage may be tax deductible, thus reducing your federal and state liabilities. Consult your tax advisor to learn more.

Cons

Risk: Whether your second mortgage is large or small, it uses your home as collateral, meaning your home is at risk if you find that you cannot make payments as scheduled.
Fees: The mortgage may have some loan origination fees. Include these when you assess whether the loan is a good idea vs. other sources of money. Spread the fees across the amount of money you will borrow to determine the equivalent interest rate they represent.
Monthly payments: Although this might be an obvious feature of the loan, it’s important to factor the new amounts for the additional mortgage into your monthly budget to be sure you will have the regular income to pay them.
Trading short–term for long-term: If you consolidate debt to get the lower interest rate of a second mortgage with a longer term, you may end up paying more interest over life of loan if short-term debt at a high rate is included in that consolidation. Be sure to consolidate the right types of debt.

Discover Home Loans offers low fixed rates on home equity loans up to 90% CLTV with $0 application fees, $0 origination fees, $0 appraisal fees, and $0 costs due at closing.

Common FAQs and requirements for a second mortgage

Before you start the application process, review these FAQs and requirements related to second mortgages.

Is a second mortgage the same as a home equity loan?

A second mortgage and a home equity loan are typically two terms for the same thing. A second mortgage is a loan secured by your home where you leverage your remaining home's equity to get cash for your needs. Your home equity is the difference between the current value of your home and what is still owed on the first mortgage (if you have one).

For example, if the market value of your home is $300,000 and you owe $200,000 on your mortgage, you have $100,000 in home equity. Second mortgages typically have a fixed interest rate, fixed monthly payment and fixed term. Lenders often suggest that you use your home equity for things that have long-term or significant value like home improvements, debt consolidation, education expenses or other major expenses rather than for everyday or unnecessary expenses since your home secures the loan.

LEARN MORE: What is a home equity loan? How does it work?

How does home equity work?

The equity you have in your home is the part of your home’s value that you own outright.

Calculate home equity as the difference between the current market value of your home and the amount you owe on your mortgage(s). You may be able to borrow against your equity when you need cash.

Here’s an example of equity:

In year 1, you buy a home for $300,000, making a 20% down payment ($60,000), and borrow a first mortgage of $240,000 from your lender. You have $60,000 in equity due to the amount of your down payment.

In year 5, after making regular payments of interest and principal, you may have paid down part of your loan and now owe only $210,000. At the same time, the appraised value of your home has gone up to $400,000 so you have seen a price appreciation of $100,000.

Now your market value of $400,000 minus your outstanding loan amount of $210,000 gives you $190,000 of equity in your home.

How much money can I take out in a second mortgage?

Generally, lenders will assign a top limit to the amount of your home’s appraised market value that they are willing to finance. To determine the amount of your home’s value that is mortgaged, many lenders use what’s called a combined loan-to-value (CLTV) ratio. CLTV is calculated by taking your existing mortgage balance(s) plus your desired loan amount, divided by your home value:

CLTV = (Loan Amount + Mortgage Balances) / Home Value

Using the previously mentioned example, here’s how you can determine how much you can borrow:

.9 = (x + $210,000) / $400,000. In this case, x=$150,000. This would mean you may be able to borrow $150,000 from your home’s equity through a home equity loan if you work with a lender that allows borrowing up to a 90% CLTV ratio.

What are the requirements of a second mortgage?

Like a first mortgage, during the application process, you will need to provide documentation of employment, sustained income, good financial history, credit score, your other debts and sufficient equity in your home.

Lenders will likely verify your employment and income information by reviewing your most recent W2 forms and recent paycheck stubs covering 30 days, if applicable. If you’re self-employed or receive income from other sources than an employer, you’ll need to provide your most recent federal income tax returns.

Your lender will obtain an automated valuation and/or conduct a formal appraisal of your home to confirm its current market value. Lenders will also access your credit report to determine your credit score. Your qualification and interest rate will be determined by all these things in addition to other underwriting criteria.

What are the terms and payback period for a second mortgage?

Lenders assign higher risk to second mortgages than to first mortgages because first mortgages take precedence in receiving proceeds from the sale of a home in the event of foreclosure.

Because of this risk difference, second mortgages generally have somewhat higher interest rates than first mortgages, but both are usually lower than unsecured loans like personal loans or credit cards. Terms for both first and second mortgages typically go up to 30 years.

What is the difference between a home equity loan and a home equity line of credit?

A home equity loan and a home equity line of credit (HELOC) are similar in that they both use your home’s equity as collateral, are typically second mortgages and will show up on your credit report.

However, a home equity loan is a fixed amount lent to you for a fixed term with payments amortized or spread over the life of the loan. A HELOC is a loan that allows you to draw out money up to the maximum amount of an approved credit line over a set period, which is usually shorter than the term of the loan.

It’s possible that you might not owe the lender anything on the HELOC until you start withdrawing from it, like a credit card. However, HELOCs may also come with additional costs such as annual fees, so make sure you verify what your lender requires. Once you do withdraw from the HELOC, you will begin making monthly payments. You can withdraw a lump sum once or withdraw money multiple times until you reach the maximum approved loan amount.

LEARN MORE: Home equity loan vs Home equity line of credit (HELOC)

Do I have to get my second mortgage from the same place as my first mortgage?

No. The first and second mortgage are totally independent. Use care and research to find the best mortgage provider that gives you the rates, terms, and services you need. Make sure you’re ready to provide all the required information about the first mortgage to expedite the process.

Does a second mortgage have any fees?

While fees may vary by lender, Discover Home Loans has no application fees, no origination fees, no appraisal fees, and no cash due at closing. Research different lenders to determine the best combination of rates, fees, and service that works for you.

Closing thoughts: How does a second mortgage work?

The name second mortgage may seem to imply that the mortgage should come from the same lender who provided the first mortgage, but that is not a requirement. Ideally, you will want to shop around to find the best terms and service. Make sure you understand all interest rates and fees so that you can compare offers from different lenders. Try to request written Loan Estimates, and compare annual percentage rates (APRs) and any potential fees. In addition to comparing the financial terms, you may want to look for reliable lenders who have demonstrated experience and good customer satisfaction ratings.

Please note: Discover Home Loans offers home equity loans and mortgage refinance opportunities, but does not offer HELOCs or purchase mortgages.