What Is A Second Mortgage? Rates, Uses and More
A second mortgage is a home loan you take out after you’ve already purchased a home. It can be a totally separate purchase mortgage secured by a second home, or it can be an additional mortgage that allows you to tap the home equity in your main home.
Either way, second mortgage rates are often slightly higher than first mortgage rates, but these loans can still make sense if you need a new home or want to access cash that can help you pay off debt, make home improvements or avoid mortgage insurance.
What is a second mortgage?
There are two distinct kinds of second mortgages:
- Second home mortgages are loans used to purchase a second home or property. How you use that second home determines whether lenders (and the IRS) will consider it a second home, vacation property or investment property.
- Common loan options: Lenders typically offer distinct loan programs for these types of purchases. Search for “vacation property loans,” “investment property loans” and “second home loans” to find them.
- Second mortgages are subordinate loans that let you access cash secured by your home equity.
Your home equity is the difference between how much you owe and your home’s value.
Since it’s common to take out a second mortgage while you still have a first mortgage on your home, the term “second mortgage” refers to how lenders are paid in foreclosure: A second mortgage loan is paid only after the first loan balance has been paid, which means that if there isn’t enough equity left, the lender may not get all of their money back. That’s why these second mortgages are sometimes also called “junior liens.”
- Common loan options: Lenders typically offer home equity loans and home equity lines of credit (HELOCs) to homeowners who want to convert some of their home equity into cash.
Second mortgage rates: What to expect
- You’ll typically pay a higher interest rate with a second mortgage. That’s because lenders are taking on more risk that they won’t be repaid if you default on the loan.
- You’ll have to choose between fixed or variable interest rates. Whether you’re shopping for a loan for a second home, or one to tap your home equity, you’ll have both fixed- and variable-rate options. Home equity loan rates are normally fixed, while HELOC rates are usually variable.
- Your credit score will partially determine your rate. Borrowers with 780 credit scores or higher are often rewarded with the lowest second mortgage rates.
- Your debt-to-income (DTI) ratio can become a limiting factor. When you’re carrying two mortgages, you’re more likely to have a higher debt load. Lenders typically won’t offer the lowest rates to borrowers with high DTI ratios.
- Your loan-to-value (LTV) ratio can affect your rate and closing costs. In most cases, the higher your LTV ratio is, the higher your rate will be.
How to get a low second mortgage rate
Shop with three to five different lenders to get the best rate. You may get a better second mortgage rate at a local bank or credit union if you also open a checking account there and have the monthly payments automatically withdrawn.
Second mortgage rate trends
Vacation home loans
A vacation home is just a second home you don’t live in full time. Whether you live in the home full time or part time and whether you rent it out is important to both mortgage lenders and the IRS. In order for the property to qualify as a second home or vacation home, you must:
- Occupy the home for more than 14 days a year or
- Occupy the home more than 10% of the number of days you rented it that year
Learn more about the IRS rules around how you can use residential properties.
Investment property loans
An investment property is one that you’ve purchased with the intention of making money. That could be through residential renting, vacation rentals, house flipping or other means. In order for the home to qualify as an investment property, you must:
- Occupy the property less than 14 days per year
- Not live in it as your primary or secondary residence
Learn more about investment property loans and rates.
Home equity loans
In most cases, a home equity loan is a fixed-rate second mortgage. You receive funds in a lump sum and pay the balance in even installments over terms ranging between five and 30 years. You’ll typically pay closing costs equal to 2% to 5% of your second loan amount and can use the cash to buy or refinance a home, or for anything else you can buy with cash.
Rates are usually higher and the qualifying requirements are more stringent than a first mortgage. For example, the maximum LTV ratio for a first mortgage is usually around 97%, but for a second mortgage, many lenders won’t go above 85%.
Home equity lines of credit
Most home equity lines of credit are second mortgages, but they can also be secured by a home without a first mortgage. A HELOC works like a credit card for a set time called a “draw period,” during which you can use and pay off the balance as needed. Some HELOCs allow you to only pay off the interest on any money you’ve borrowed during the draw period. However, once you enter the repayment period, you’ll begin repaying the loan balance. You’ll usually have 15 to 20 years to pay the loan in full at a variable interest rate.
Unless you have a no-closing-cost HELOC, closing costs will likely run you 2% to 5% of the credit line. You may also pay ongoing fees for account maintenance or a close-out fee when you pay off the HELOC early. Some lenders also impose minimum withdrawal requirements and inactivity fees that penalize you if you don’t utilize the credit line very much.
How does a second mortgage work?
The second mortgage process is similar to getting a first mortgage: You fill out an application, and the lender reviews your income and credit history and verifies your home’s value with a home appraisal. However, there are a few notable differences when it comes to second mortgage requirements:
- You can’t exceed the lender’s combined loan-to-value (CLTV) ratio limits. Your LTV limit is calculated by dividing how much you’re borrowing by your home’s value. With a second mortgage, the lender adds the balance of both your first and second mortgage to determine your CLTV ratio.
- Conventional second home mortgage loans cap your CLTV at 75% to 95%, depending on how you plan to use the property and how many units it has.
- Most second mortgage (junior lien) lenders typically cap your CLTV at 85%, although some may lend you up to 100% of your home’s value.
- You must qualify with two mortgage payments. A second mortgage means you’ll make two house payments each month.
- Second home mortgage lenders often cap your DTI ratio in the range of 41% to 50%.
- Second mortgage (junior lien) lenders usually require a maximum 43% DTI ratio, although some lenders may stretch the maximum to 50%. Your DTI ratio is calculated by dividing your total monthly debt, including both mortgage payments, by your gross income.
If you have a rough idea of your home’s value and your current loan balance, try our home equity loan calculator to estimate how much equity you may qualify to borrow.
When to use a home equity loan or HELOC to buy a second home
While you may assume that a second home mortgage is the only choice for purchasing a second home, you can actually use it in conjunction with a home equity loan or HELOC. Using a home equity loan or HELOC to cover the down payment can make sense if:
- You’re buying a rental property. If you need funds for a down payment on a rental property, a home equity loan or HELOC might be your best choice — and as soon as you get renters into the home and your investment starts yielding profits, you’ll have money coming in to help repay the loan.
- You need extra cash to buy a home before your current home sells. It can be hard to time the sale of your current home with the purchase of a new home. If you need to buy a new home before completing the sale of your current home, you can take out a first mortgage and a second mortgage that covers the profit you’re expecting from your current home. When your old home sells, you can pay off the second mortgage with the sale proceeds.
- You want to avoid mortgage insurance on a home purchase. You can buy a home with a down payment as low as 10% with a “piggyback” second mortgage. You’d take out a first mortgage for up to 80% of the home’s price, and the second mortgage “piggybacks” on the first, allowing you to avoid paying mortgage insurance.
Second mortgages and home improvements
Second mortgage interest charges may be tax deductible if the funds are used for home improvements. In order to deduct that interest, you’ll have to itemize your deductions when you file your taxes and take the home mortgage interest deduction.
Pros and cons of second mortgages
| If you use the money on home improvements, to start a business or for investing, you can create equity or future income. You can access your home equity without refinancing your first mortgage. You may be able to deduct second mortgage interest from your taxes if the funds are used for home improvements or to buy the home. You can buy a home with less than 20% down and avoid paying mortgage insurance. You can consolidate debt at a lower interest rate than you’d pay with a personal loan or credit card. | You could lose your home if you can’t make your payments and the lender forecloses. You’ll pay a higher interest rate than a first mortgage. You’ll need to meet more stringent DTI and LTV requirements. You'll net less profit when you sell your home if you used the second mortgage to tap home equity. You’ll have to cover the costs and fees that come along with a second mortgage like appraisal fees, origination fees and other closing costs. |
Can I get a second mortgage with bad credit?
Yes, there are both second home loans for bad credit and junior lien second mortgages available for borrowers with lower credit scores.
That said, home equity loan and HELOC lenders will likely reduce how much you can borrow depending on how low your scores are. Home equity lenders generally require at least a 620 credit score, although some may set a minimum as high as 680.
If you have a lot of equity but a lower credit score, consider a cash-out refinance backed by the Federal Housing Administration (FHA). An FHA cash-out refinance allows you to borrow up to 80% of your home’s value with a score as low as 500.