What is a second mortgage? How does it work?

Common FAQs and requirements for a second mortgage

Before you apply for a second mortgage, review these FAQs and requirements: 

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

A second mortgage is a loan secured by your home that may let you leverage your home's equity to get cash for your needs. A home equity loan is a type of second mortgage. It typically has a fixed interest rate, fixed monthly payment, and fixed term. 

Your home equity is the difference between:

• The current market value of your home and 
• The balance of your mortgage(s) and any other debts secured by the property.

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. 

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

How does home equity work?

Equity is the part of your home’s value that you own outright. 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 after making a 20% down payment ($60,000) and taking out a mortgage of $240,000. You should have $60,000 in equity due to the amount of your down payment.

In year 5, after making regular payments of mortgage interest and principal, you have paid $30,000 toward your loan and now owe $210,000. At the same time, the market value of your home has gone up to $400,000, an increase 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?

Many lenders use combined loan-to-value (CLTV), as well as other factors, to determine your loan amount. 

CLTV is calculated by adding your existing mortgage balance(s) and any other debts secured by your property with your desired loan amount. This number is then divided by your appraised home value:

CLTV = (Loan Amount + Mortgage Balances and Other Secured Debts) / Appraised Home Value

Lenders typically set a CLTV limit, which may impact how much you may be able to borrow. For example, a lender may have a CLTV limit of 90%.

What are the requirements of a second mortgage?

When applying for a second mortgage, you typically provide the lender with documentation verifying your income, employment status, and other factors. 

The lender may verify your income and employment by reviewing your most recent W2 forms and paycheck stubs. If you’re self-employed or receive income from sources other than an employer, you may need to provide your most recent income tax returns.

Generally, the lender will obtain an automated valuation and/or formally appraise your home to determine its current market value. They may also access your credit report to assess your credit history and score. 

What are the terms for a second mortgage?

Second mortgages often have higher interest rates than first mortgages. However, they may have lower rates than other types of financing. Term lengths for both first and second mortgages typically go up to 30 years.

What is the difference between a home equity loan and a HELOC?

A home equity loan and a HELOC are similar in that they both use your home’s equity as collateral. However, there are some differences.

A home equity loan is typically a fixed amount lent to you for a fixed term, with payments spread over the life of the loan. A HELOC is an open-ended line of credit that allows you to withdraw money up to a predetermined amount during the draw period.

LEARN MORE: HELOC vs Home Equity Loan: Which is Right for You?