Second Mortgages: What You Need to Know

Oliver Twist, Charles Dickens’ fictional character who’s known for requesting more food, appreciated the meaning of seconds. He had a need – he was hungry – and he knew that a second helping of food would satisfy him. Second mortgages fill a need, as well. If you need cash, and have accumulated equity in your home, a second mortgage can be the perfect financial food, thanks to their relatively low interest rates, and the comparatively simple application process.

Flavors of second mortgages

A second mortgage derives its name from the fact that it’s an additional borrowing to your primary, or first, home loan. It is “subordinate” to your first mortgage – if you default on your loan, all proceeds from the property liquidation go to pay off the first mortgage before the second. Because lenders take a greater risk on second mortgages, the interest rate they charge is generally higher.

There are two types of second mortgages – a home equity loan, and a home equity line of credit (HELOC). A home equity loan gives a single lump-sum payment to the borrower at a fixed rate. Like a traditional mortgage, there are fixed interest payments over a specific time period, and the monthly payment never changes.

A HELOC, on the other hand, works more like a credit card. The bank gives you a line of credit from which you can draw against for a designated period of time. The interest rate varies based on an index, and you only pay interest on the amount you withdraw.

If you have good credit, banks will generally allow you to borrow up to 80 percent of the outstanding equity in your home. The application process is relatively painless, and many banks will pre-approve you online or over the telephone. You’ll be required to provide documentation for your income, employment, and information about your primary mortgage, and there’ll often be a small application fee. But there’s a lot less paperwork than was required of your first loan.

Purpose of second mortgage

Consumers flock to second mortgages for many reasons. First, the interest rates tend to be a lot lower than credit cards, another instrument for borrowing funds. If you’re disciplined, you could use a home equity loan to consolidate high-interest debts, but there’s danger on that path -- if you don’t pay it off diligently, you have the potential of getting further into debt.

In addition to debt consolidation, people take advantage of the second mortgages option for home improvements, or as a cheaper alternative to car loans or borrowing for college tuition. An additional benefit of second mortgages is that the interest is generally tax deductible.

Oliver Twist was a first rate novel about a character who wanted a second helping of food. If it had been set in today’s economic climate, Oliver could have used a second mortgage to open his very own restaurant and never have gone hungry again.