Second Mortgage Explained: How They Work & Benefits

How Does a Second Mortgage Work?

Many people opt to take a second mortgage out on their homes to help with emergency expenses. Second mortgages can be a way for many people to adjust their financial obligations and to pay off high-interest credit cards or unexpected hospital bills.

These mortgages are sometimes referred to as home equity loans, because it is the amount of equity that you have in the home that qualifies you for the loan. Equity simply means how much of the home you actually own, versus the amount that is mortgaged. For instance, if you house is appraised for $250,000 and you owe $200,000 to a mortgage company, your equity in the home is $50,000. That would be the maximum you could borrow on a second mortgage.

The bank that holds the first mortgage would be the one most willing to extend a second mortgage on the home. They are already the lien holder, so the process would be faster, which means less paperwork and probably less money you would have to pay.

Another mortgage company may want you to pay for a new appraisal report on the property before they would discuss a second mortgage. Your original lender may simply do a drive-by to see that the home is in good repair and may even accept the latest real estate tax bill estimate of the property's market value.

A second mortgage will go through a closing process just like the first mortgage but will not cost as much, because the title search work is already done from the first mortgage. As you can see, the first and second mortgages are pretty similar. But there are a few differences that one should be aware of.

Interest rates for a second mortgage will not be as low as those for a first mortgage. The bank will determine that the second mortgage is a higher risk than the first mortgage and therefore will charge a higher interest rate. You will not get as many years to extend the second mortgage out as with a first one. This too is because of the risk of a possible default.

Most second mortgages come with a monthly payback amount just like the first mortgage, so you may find yourself paying high payments when you combine the two. But a second mortgage is a better option than a total refinance, especially if you have quite a bit paid down on the original mortgage.

Some banks will work out different options to pay back the second mortgage. These options can range from monthly interest and principal payments to yearly balloon payments. A balloon payments means that a certain amount is due once a year. The exact type of repayment will be up to your preferences and the bank's policy.

Some second mortgages may either offer fixed-rate interest or adjustable interest. Make sure that your bank clarifies which one they are offering you and make sure that you fully understand the terms of an ARM.