What is a second mortgage, and how does it work?

The cost to buy a home is at a record high, and homeowners have significant equity in their homes as a result of the runup in values. According to property information and data analyst CoreLogic, the average U.S. mortgage-owning homeowner possesses $305,000 in equity as of Q1 2024, a gain of $28,000 in the past year.

One of the ways homeowners can tap their equity for ready money is by taking out a second mortgage — so-called because it uses the home as collateral for the debt, just as the original mortgage used to buy the home does.

Before you can take equity from your home, you need to understand all your options. Let’s look more deeply into how second mortgages work.

What is a second mortgage?

When you take out a second mortgage loan, you borrow against the equity you’ve built up in your home. Equity refers to the amount of the home you own outright, as opposed to the amount you still owe; in other words, the difference between the value of your home and the remaining balance on your first mortgage.

Common examples of second mortgages include a home equity loan and a home equity line of credit (HELOC). These two tools are the main ways homeowners typically access their equity stake.

You can use funds from a second mortgage for a variety of purposes. Some of the most common uses of second mortgage loans include consolidating other debts (especially high-interest credit card balances) and financing home improvements or repairs.

How does a second mortgage work?

A second mortgage works a lot like a first mortgage — in the opening stages, anyway.

To obtain a second mortgage, you typically need to do the same things you did to qualify for a primary mortgage. The process includes submitting an application to a lender and providing documentation regarding your income, debts and assets. You might also need to get an appraisal to confirm the current value of your home.

Qualifications for second mortgages vary, but many lenders prefer that you have at least 15 percent to 20 percent equity in your home. You can typically borrow up to 85 percent of your home’s value minus your current mortgage debts. If you have a home worth $300,000 and $200,000 remaining on your first mortgage, for instance, you might be able to borrow as much as $55,000 through a second mortgage: ($300,000 x 0.85) – $200,000.

Requirements for applying for a second mortgage

To apply for a second mortgage, you must meet the following requirements:

• Own at least 15 to 20% of the home outright
• Have a remaining balance on your current mortgage that’s less than 80%/85% of the home’s value
• Have a credit score of 620 or (recommended) higher

Can you get a second mortgage if you have bad credit?

Qualifying for a second mortgage with bad credit is challenging, especially since lenders set a high bar for these inherently riskier loans to begin with: Many expect your FICO score to be at a minimum “good” (670) or high “fair” (640-669). Still, qualifying is possible, especially if you have a sizable equity stake. To improve your chances, consider going to your first mortgage lender, with whom you already have a relationship. Another option is to secure a co-signer with a strong credit profile, which can make you a more attractive candidate. You could also consider making a larger down payment.

If you do get approved, expect higher interest rates and stricter terms — the price you pay for your less-than-brilliant credit.

What are the pros and cons of getting a second mortgage?

Second mortgages can be helpful in a variety of situations, but they do have drawbacks to consider.

Types of second mortgages

Borrowers who wish to take out second mortgages can choose between two basic types: home equity loans or home equity lines of credit.

Home equity loan

A home equity loan is most similar to a first mortgage. You receive all of the money upfront and pay it back over time with interest in fixed monthly payments. These loans are ideal for situations in which you need a sum of cash at one time, such as paying off a big debt or paying for one large single expense, like a kitchen renovation or a new swimming pool.

Before applying, do some research into current home equity loan rates. Typically, rates are a few percentage points higher than mortgage rates. Bankrate’s home equity loan calculator can help you see if such a loan makes sense for you, and how much money you could tap.

Home equity line of credit (HELOC)

A HELOC is a line of credit, similar to a big credit card. Once it’s established, you can draw on it over several years, as often as you want and in the amounts that you want. You’re charged interest only on the amount that you actually withdraw. You can repay the sums you borrow, then borrow again.

HELOCs can be a great option if you’re not sure exactly how much money you’ll need or if you’ll need it over a long period of time. Examples may include paying college tuition or embarking on a remodeling project — like a home addition — that’ll take a good many months and whose contractors will be reimbursed in stages.

HELOC interest rates typically run a few percentage points higher than mortgage rates and slightly above home equity loan rates. However, unlike the other two, they are usually variable. That means they can fluctuate, rising and falling with interest rates in general. Check out Bankrate’s HELOC payoff calculator to see if this option makes sense for you.

What’s the difference between a second mortgage and a refinance?

Refinancing your mortgage is quite different from getting a second mortgage.

The most significant difference is that a second mortgage is a brand-new loan that you get in addition to your existing mortgage. Refinancing a mortgage replaces it entirely: You’ll pay off your old loan with the proceeds from the new one.

There’s a particular type of refinancing that allows you to tap your home equity, too: a cash-out refinance. With a cash-out refi, you take out a new mortgage with a bigger balance than your current mortgage, pocketing the difference in cash. The extra amount is based on the value of your home equity. Of course, this move leaves you with a bigger loan to pay off, and larger payments (usually fixed) to make each month.

Cash-out refinance funds and home equity loan funds can be used for similar reasons (since the refis take longer to obtain, they may not be as good for emergency expenses, though). Refinancing can be a good choice if, in addition to obtaining cash, you want to adjust the repayment term of your existing mortgage or can secure a lower interest rate on the new loan.

In contrast, home equity loans or HELOCs would be the better option if you want to hang onto your current mortgage’s low-low rate, or unsure of how long or how much money you’ll need. However, they work best if you own a good chunk of your home free and clear, since your outstanding mortgage balance will impact how big an additional loan you can get. If you still owe a lot, the refi might be the better scenario after all.

If you use a second mortgage to buy, build, or substantially improve the home you use to secure the loan, the interest may be tax-deductible, provided you itemize deductions on your tax return.

Final word on second mortgages

The best reason to get a second mortgage is a project that will increase the worth and ultimate market value of your home via a remodel, renovation or expansion. By investing in your property, you’re using home equity to build more equity, in effect.

Using the second mortgage to pay off other loans or outstanding credit card balances is another good reason — especially if those obligations carry a higher interest rate. Replacing more expensive debt with cheaper debt can be a smart financial strategy.

However, if you’re thinking about getting a second mortgage to buy a car, pay for a vacation or throw a big party, think twice. Do you really want to risk your home for discretionary items or experiences?

Second mortgage FAQ

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

  Both home equity loans and HELOCs are considered second mortgages, as they are secured by a lien on your home.

• Are second mortgage rates higher than first mortgage rates?

  Second mortgage rates are likely to be higher than primary mortgage rates. For example, in late June 2023, the current average 30-year fixed mortgage interest rate was 6.96 percent, vs. 8.60 percent for the average home equity loan and 9.17 percent for the average HELOC. The disparity is due partly to the loans’ terms (second mortgages’ repayment periods tend to be shorter, usually 15 to 20 years), and partly due to the lender’s risk: Should your home fall into foreclosure, the lender with the second mortgage loan will be second in line to be paid. However, you may find that second-mortgage rates still may be lower than rates on unsecured debt like personal loans or credit cards.

• What are the alternatives to a second mortgage?

  If you’re not sure a second mortgage is right for you, there are other options. A personal loan lets you borrow money for many purposes. They tend to cost more and have lower limits, but they don’t put your home at risk and are easier and quicker to obtain. A home improvement loan, like the Federal Housing Administration’s FHA 203(k) rehab loan, is another option if you’re specifically looking to pay for projects around the house. If you’re looking to turn home equity into a source of cash flow for retirement and are of a certain age, you may want to consider a reverse mortgage.

• Can you get a second mortgage to buy another house?

  You can use your home equity to buy a second home, if you have enough equity and meet the eligibility requirements. But the question is, would you want to? While you can potentially borrow at lower cost than unsecured personal loans, using your home equity to buy a second home can be risky. Not only are you trading your equity for more debt, you also could potentially lose your home if you miss payments.