A common question we hear often is “how does a second mortgage work?” and these questions are usually followed by requests for more specific details.
A second mortgage is similar to the first mortgage you took out to buy your home. However, a second mortgage is taken from the equity on your home.
What is a Second Mortgage and How Does it Work?
A second mortgage is a loan you can take out against the value of your home. In a second mortgage, your home is put up as collateral. This means you could risk foreclosure if you’re not able to pay the second mortgage.
What do you Need to get a Second Mortgage?
To get a second mortgage, you’ll need to have sufficient equity in your home. The equity is the difference between the value of your home and how much you owe on your first mortgage. For instance, if your home is worth $500,000 and you owe $300,000 on your mortgage, you have $200,000 of equity in the home.
Like a first mortgage, a second mortgage must be repaid at a certain interest rate (either fixed or variable) over a specified term. The lender of the first mortgage is paid out first if the home faces foreclosure and is sold. This means the lender holding the second mortgage may not receive much in this situation. In exchange for taking on this additional risk, the interest rate on a second mortgage is almost always higher than the rate on a first mortgage.
Second Mortgage vs. Refinancing
Rather than getting a second mortgage, another option is to refinance your primary loan. This option allows you to potentially borrow more on your new mortgage than on your current mortgage. This gives you extra cash to spend immediately. However, you will have to pay interest on this loan, and you may have to pay a prepayment penalty when refinancing.
Types of Second Mortgages
Beyond knowing how to get a second mortgage, it’s also important to understand the different types of second mortgages that are available. One of the most common is a Home Equity Line of Credit (HELOC).
A Home Equity Line of Credit is a revolving line of credit that is backed by your home. These loans are usually structured so that the lender guarantees to lend a maximum amount, but you only pay interest on what you need. For instance, if you get a HELOC for up to $100,000, then the lender is promising to lend you up to $100,000. However, if you only need to use $50,000, you only pay interest on this amount. You make monthly payments until the balance you borrowed is paid back.
Another type of second mortgage is a home equity loan. This comes in the form of a one-time lump sum payment. For instance, if in the above situation, you take out a home equity loan for $100,000, you receive a payment of $100,000 that you can use however you’d like. You will repay this loan over time with interest being paid on the full amount.
Second Mortgage Rates
As mentioned, the interest rates on second mortgages tend to be higher than those on first mortgages. That’s because the lender is taking on additional risk and they could potentially get nothing if you need to sell your home. However, these interest rates still tend to be significantly lower than credit cards and some other unsecured loans.
The specific rate you pay will depend on several factors that are unique to you, including the amount of equity you have in your home, your income, your credit score, and more.
Working with an experienced broker can help you get the best possible interest rate. The team at Axiom Mortgage Solutions has the skill and experience to help you understand the different second mortgage options and work with lenders to get you the best possible rate. To speak with our team, contact us online or call our Tecumseh, Ontario office at 519-735-1440 or our Leamington, Ontario office at 519-326-4978.
