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How Does A Second Mortgage Work?

Posted on May 13, 2022 by Jivan Sanghera

Many homeowners are not aware that they can take out a second mortgage on their properties.

A second mortgage, also called a home equity loan, is a second loan taken out on a property that is already mortgaged. In simpler terms, it’s when homeowners have two mortgages for one property.

What Is A Second Mortgage?

Second mortgages are secondary loans that homeowners can take out on a property with a primary mortgage. However, this money is not to pay off the cost of the property. Instead, the funds cover other expenses like credit card debt, auto loans, and home renovations.

Homeowners receive a lump sum payment of their second mortgage upfront. They then need to make payments on both their first and second mortgages at the same time. However, second mortgages are typically interest-only payments. Interest payments help pay off the interest earned on the loan which depends on the loan interest rate. Interest rates on a second mortgage will generally be higher than the first loan secured. Seconds mortgages are available at either a variable or fixed interest rate.

Primary Mortgage vs. Second Mortgage Loans

A primary mortgage is an original mortgage used to buy a house. It’s the home loan that covers the cost of the property beyond the down payment and some closing costs. Typically, primary mortgages will make up anywhere from 95% or less of homes' purchase price. A second mortgage is much different.

A second mortgage loan is not equal to the cost of your home. Instead, the amount of money that you can borrow will depend on the amount of equity in your home. The total of a first and second mortgage can be as much as 80% of your home's value, minus the balance of your primary mortgage.

What Is Equity?

Equity is the market value of your unencumbered interest in your home. In simpler terms, it is the amount of money that you have paid for your home, outstanding mortgage balance not included.

For example, you paid a $20,000 down payment on a $400,000 house. Your first mortgage covered the remaining $380,000. You have paid $25,000 in monthly mortgage payments since you first purchased the property. When you first bought the home, your home's equity was $20,000. After paying off a portion of your existing mortgage, the value of your home equity is $45,000.

How Is A Second Mortgage Different Than A Line of Credit?

A second mortgage is much different than a home equity line of credit (HELOC) despite its reliance on equity.

First, a HELOC is a line of credit secured against your home. It works like just any other credit line; you take out money during the draw period and spend it. Then, you pay it back before you can borrow again. HELOCs are like high-interest credit cards. In contrast, second mortgages are loans with mortgage rates. They are used to consolidate debt into a single loan that can be paid off monthly payments alongside a monthly mortgage payment.

The main similarity between second mortgages and HELOCs is the collateral: your home. You risk losing your home if you do not pay back the money you borrow.

How To Get A Second Mortgage

A home equity loans are ideal for debt consolidation. Rather than pay off personal loans and your mortgage separately, you can combine them into first and second mortgages. This will help fix your bad credit, transfer high-interest debts to a lower interest rate, and boost your low credit score.

Here is how you can apply for a second mortgage:

  1. Pay down your first mortgage. Mortgage lenders require homebuyers to have over 20% equity in their homes before borrowing money. They also need to be able to pay their monthly payments without exceeding their Total Debt Service Ratio.
  2. Find a second mortgage lender. A second mortgage must be with a different lender than the primary lender. Many mortgage lenders and credit unions are willing to help.
    Apply. Visit your financial institution to apply for a second mortgage. You will need to provide personal finance information.
  3. Pay and spend. Borrowers will need to pay several fees to get a second mortgage. They will need to pay origination fees, homeowners insurance (rates vary), title search fees, legal fees, and appraisal fees. After, you have your home equity loan to spend.

Find A Second Mortgage Lender With Circle Mortgage

At Circle Mortgage, we make getting a second mortgage simple. Call us today to speak with our mortgage broker. We can answer second mortgage FAQs and help you decide whether an additional loan is right for you.

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