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What is a second mortgage loan? It's any loan secured by the collateral in your home, except for the main, primary mortgage used to purchase the home itself.

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second mortgageSecond mortgage loans fall into two main categories:  1) Home equity loans, where you borrow against the equity in your home to obtain funds for some purpose, and 2) piggyback loans, which are used to supplement a primary mortgage when buying a home.

A mortgage is any loan backed by real estate as collateral; it doesn't necessarily have to be a loan used to purchase the home. That's why home equity loans are considered 2nd mortgages.

They're called a 2nd mortgage because they're a second lien loan, or of second priority to your primary, first-lien mortgage. In the event of a foreclosure, the primary mortgage/first lien gets paid off first. Any 2nd mortgage only gets paid after the primary loan has been paid in full – they're second in line for payment.


2nd mortgage rates

Interest rates on a 2nd mortgage are generally lower than on unsecured loans, because they're backed by your home as collateral.  Unsecured loans like credit cards or personal loans don't have anything to back them up, so they present a bigger risk to the lender. Secured loans are less risky for lenders, so they're willing to offer better rates on second loans.

At the same time, 2nd mortgage rates are higher than the rates on primary, first-lien mortgages.  The fact they don't get paid off in a foreclosure until after the primary lien has been fully paid means there's a greater risk they may not be paid or only partially repaid in that event – so second mortgage lenders charge higher rates to compensate for that risk.


Types of second mortgages

As noted above, there are two main types of second mortgage loans, home equity loans and piggyback loans. The first of these also comes in two types, a standard home equity loan and a home equity line of credit (HELOC). We'll look at each of these separately; click on the highlighted links for more information on each.


Home equity loan

A standard home equity loan is a simply a loan in which you're putting up part of the value of your home as collateral. You receive a sum of money and repay it over a certain predetermined time, often 5-15 years. These are typically set up as fixed-rate loans, though they are available with adjustable rates as well.

To get a home equity loan, you need home equity. In other words, you're borrowing against the portion of your home that's paid off, or more precisely, the portion of the value of your home that exceeds what you owe on your primary mortgage.  So if you have a $300,000 home and owe $120,000 on your primary mortgage, you have $180,000 in home equity you could potentially borrow against.

You can generally use the funds from a home equity loan for anything you wish, although some home equity loans are restricted to a specific purpose, like home improvements.


Home equity line of credit (HELOC)

A home equity line of credit HELOC is a special type of home equity loan that, instead of giving you money up front, sets up a line of credit that you can borrow against as you wish. It's like a credit card secured by your home equity; in fact, lenders will often give you a card to use for drawing funds. home equity second mortgage

When your second mortgage loan is a HELOC, the lender will set aside a portion of your home equity to back the line of credit, say $40,000. You can then borrow against that maximum at whatever times and in whatever amounts you wish. This makes HELOCs good for situations where you need funds for varying expenses over time.

HELOCs have a draw period, usually 10 years, when you can borrow funds, and a repayment phase, often 20 years, when you must repay the loan.  They have an adjustable rate during the draw, but often can be switched to a fixed rate during the repayment phase.


Piggyback loans

A piggyback loan is an entirely different category of second mortgage loans.  Rather than borrowing against your home equity, a piggyback loan is in addition to the primary mortgage when buying a home. In other words, you're using two mortgages to make the purchase.

For example, when buying a $300,000 home, you might pay for it using a $240,000 primary mortgage, a $30,000 piggyback loan and a $30,000 down payment.

Why do this? There are two reasons. The first is to cover part or all of the down payment in order to avoid paying for private mortgage insurance (PMI).  The second is to avoid taking out a jumbo loan when buying a more expensive home.

Mortgage insurance is required on any mortgage with a down payment of less than 20 percent and is usually charged as a monthly premium.  So a borrower might use a piggyback loan and down payment that equal 20 percent of the home price and not have to pay for PMI on the primary mortgage. piggyback second mortgage

In the example above, the $240,000 primary mortgage is 80 percent of the price and the $30,000 piggyback loan and down payment are each 10 percent. This is known as an 80-10-10 and is one of the most popular piggyback second mortgage loans.

During the housing bubble, it was very common to use an 80-20 piggyback loan to avoid making a down payment at all, with the piggyback covering 20 percent of the purchase price. But those are practically nonexistent these days.

The other reason for a piggyback second mortgage is to avoid taking out a jumbo loan.  Jumbos are loans that exceed the maximum you can borrow with a Fannie Mae or Freddie Mac conforming mortgage. Depending on local home values, these limits range from $417,000-$625,500 in the lower 48 states (higher limits are allowed in Alaska and Hawaii).

Jumbo loans typically charge higher mortgage rates than Fannie/Freddie mortgages do. So borrowers buying a high-value home will sometimes take out a conforming mortgage for the Fannie/Freddie maximum, then cover the rest with a piggyback loan and down payment.  Depending on what lenders are charging for 2nd mortgage rates, this can provide a significant savings.


Downsides of a 2nd mortgage

Second home loans do have certain disadvantages. The main one is that, as with any type of mortgage, you could lose your home if you fail to keep up with the payments. It doesn't matter if you stay current on your primary mortgage, your second mortgage lender can still foreclose if you fall behind on just your 2nd mortgage payments.

As noted above, 2nd mortgage rates are also higher than rates on a primary mortgage. So in some cases it may be better to do a cash-out refinance rather than take out a second mortgage loan. That's particularly true if you can lower your primary mortgage rate by doing so.

In addition, having a 2nd mortgage can make refinancing more difficult. First, a 2nd mortgage will tie up some of your home equity, and lenders generally want to see a fair amount of home equity to approve a refinance.

Having a second mortgage loan can also block the refinance of your primary mortgage.  When you refinance your primary mortgage, your second mortgage loan becomes the first lien unless it is resubordinated to the new primary loan. But second mortgage lenders are often unwilling to do that and lenders will not refinance a primary mortgage unless it will be a first lien.

The solution is usually to refinance the second mortgage by rolling it into the primary one and simply refinancing both of them. But you'll generally need to have about 10-20 percent equity over and above the two mortgages in order to do that.

    Published on November 13, 2015