What Is a Second Mortgage? How It Works, Pros & Cons, and Alternatives

Key Takeaways

• A second mortgage is a type of loan that uses your home as collateral and is secondary to your primary mortgage.
• Two main types of second mortgages are home equity loans and home equity lines of credit.
• Funds from a second mortgage can be used for a wide range of purposes, making them a popular choice for homeowners.
• There are other options for accessing your home equity if a second mortgage isn’t the right fit for you.

Homeowners today are sitting on significant equity — an average of $300,000, according to the property data firm Cotality. But many homeowners aren’t sure how to access that money wisely.

A second mortgage is a way to borrow against the equity you’ve built in your home, even as you continue to pay down your primary mortgage. While your first mortgage is the loan you used to purchase the home, a second mortgage can be applied to a variety of other uses, making it a convenient source of funds for many homeowners.

Below, we’ll cover how a second mortgage works, how to calculate home equity, and current interest rates for second mortgages. We’ll also go over what alternatives exist so you can move forward confidently with the right solution for your needs.

What Is a Second Mortgage?

A second mortgage is an additional mortgage that uses your home as collateral so you can borrow money.

Unlike a first mortgage, which is the home loan you used to purchase your home, a second mortgage can be used for a variety of needs. Many homeowners rely on a second mortgage to gain access to their home equity, using those funds to pay for home improvements, higher education, or as a down payment on another home.

The two main types of second mortgages are home equity loans (HELs) and home equity lines of credit (HELOCs). Both let you borrow against the equity you’ve built in your home; a HEL typically offers a lump sum with fixed payments, while a HELOC offers a revolving line of credit and variable interest rates.

Although many people use the terms “second mortgage” and “home equity loan” interchangeably, they’re not the same thing. A second mortgage is a broad category of credit that uses your home as collateral and is secondary to your primary mortgage. A home equity loan is one type of second mortgage.

How Does a Second Mortgage Work?

When you take out a second mortgage, you agree that if you fail to repay the loan, the lender can take your home and sell it to recoup their costs.

However, since you already have a mortgage on the home, the second mortgage is subordinate to the first. In lender terms, the first mortgage is the primary lien, and the second mortgage is the junior lien. That means the lender for the first mortgage is first in line for repayment if your home is sold or foreclosed. The lender for the second mortgage is second in line for repayment.

If you choose a home equity loan as your second mortgage, you’ll generally receive a lump sum up front, which you pay back with interest in equal installments. Home equity loans typically have terms of 10 or 15 years, though terms as short as 5 years or as long as 30 are available.

Home equity lines of credit are a type of revolving credit line that lets you repeatedly borrow during the draw phase, as you need money, then repay with interest during the repayment period. They tend to have adjustable interest rates and payments that can change periodically. The draw period is usually 10 years, with a repayment period of 10 or 20 years.

Second Mortgage Interest Rates — What to Expect

The interest rate for a second mortgage is influenced by a few different factors: your credit score, the loan-to-value ratio (LTV) of the home, market conditions, and the lender’s own policies.

If you want lower interest rates, it helps to have a strong credit profile. That tells the lender that you have a history of repaying your debts on time and that you can manage what you borrow.

A low LTV can help you qualify for lower interest rates, too. For example, an LTV of 80% means that you’re borrowing only 80% of your home’s value, keeping 40% in equity. That’s less risky for the lender than a higher LTV of 90% or even 100%. 

Something to keep in mind about interest rates for second mortgages is that they tend to be higher than rates for first or original mortgages, since the lender takes on more risk with a lien in second position.

And as you’re weighing fixed interest rates vs. variable rate options, consider that fixed rates will stay the same over the life of the loan, even if market rates fall. Variable rates have the potential to move up or down periodically. Some lenders offer low introductory rates, with the rate going up after a period. Consider how that could affect your payments if you’re thinking about a HELOC.

How to Use a Second Mortgage Calculator

A second mortgage calculator can help you estimate what your payments might be with your new loan. You’ll enter the loan amount, interest rate, and term, and the calculator will show you the estimated monthly payment and interest amount.

For example, suppose you borrow $100,000 with a home equity loan or a HELOC with a 10-year term and an interest rate of 7.5%.

If you enter those figures into a second mortgage calculator like this one from myFICO, it will yield a monthly payment of $1,187 for a HEL and $625 for a HELOC since a homeowner would only be making interest only payments for the first 10 years of the HELOC.

Run your own numbers on a potential second mortgage to see what it could cost before committing.

Pros and Cons of a Second Mortgage 

Second mortgages are a popular way for homeowners to finance big expenses like home renovations because they offer several advantages over other types of loans. However, there are some drawbacks to consider, too. It’s wise to carefully consider both the benefits and the risks involved.

Pros

• Large loan amounts: You can access a larger lump sum than you typically can with other loan types.
• Potentially lower rates: Second mortgage interest rates tend to be lower than rates for personal loans or placing expenses on a credit card.
• Interest may be tax deductible: You may be able to deduct the interest paid on a second mortgage on your federal taxes, provided the loan was used to “buy, build, or substantially improve the residence,” according to the IRS. Talk to a tax advisor about your situation.

Cons

• Risk of foreclosure: Any time your home is used as collateral for a loan, there is a risk of foreclosure if you fail to repay.
• Additional monthly payment: A second mortgage also adds an additional monthly payment to your budget, which could make it more challenging to save for the future or spend money on other priorities.
• Closing costs: A second mortgage is still a mortgage and will require you to pay closing costs before it is settled.
• Higher rates than first mortgage: Though rates are lower than with personal loans, they’re still higher than interest rates on first mortgages. That could make it more costly to borrow than you were expecting.

Alternatives to a Second Mortgage

A second mortgage isn’t the only way to tap your home equity and access funds for large expenses. Consider these other options for accessing home equity before deciding on the right method for your needs.

How to Use a Second Mortgage Calculator

A second mortgage calculator can help you estimate what your payments might be with your new loan. You’ll enter the loan amount, interest rate, and term, and the calculator will show you the estimated monthly payment and interest amount.

For example, suppose you borrow $100,000 with a home equity loan or a HELOC with a 10-year term and an interest rate of 7.5%.

If you enter those figures into a second mortgage calculator like this one from myFICO, it will yield a monthly payment of $1,187 for a HEL and $625 for a HELOC since a homeowner would only be making interest only payments for the first 10 years of the HELOC.

Run your own numbers on a potential second mortgage to see what it could cost before committing.

Pros and Cons of a Second Mortgage 

Second mortgages are a popular way for homeowners to finance big expenses like home renovations because they offer several advantages over other types of loans. However, there are some drawbacks to consider, too. It’s wise to carefully consider both the benefits and the risks involved.

Pros

• Large loan amounts: You can access a larger lump sum than you typically can with other loan types.
• Potentially lower rates: Second mortgage interest rates tend to be lower than rates for personal loans or placing expenses on a credit card.
• Interest may be tax deductible: You may be able to deduct the interest paid on a second mortgage on your federal taxes, provided the loan was used to “buy, build, or substantially improve the residence,” according to the IRS. Talk to a tax advisor about your situation.

Cons

• Risk of foreclosure: Any time your home is used as collateral for a loan, there is a risk of foreclosure if you fail to repay.
• Additional monthly payment: A second mortgage also adds an additional monthly payment to your budget, which could make it more challenging to save for the future or spend money on other priorities.
• Closing costs: A second mortgage is still a mortgage and will require you to pay closing costs before it is settled.
• Higher rates than first mortgage: Though rates are lower than with personal loans, they’re still higher than interest rates on first mortgages. That could make it more costly to borrow than you were expecting.

Alternatives to a Second Mortgage

A second mortgage isn’t the only way to tap your home equity and access funds for large expenses. Consider these other options for accessing home equity before deciding on the right method for your needs.

• Cash-out refinance: This kind of refinance replaces your existing primary mortgage with a new one, borrowing a slightly higher amount and taking the difference in cash. A cash-out refi still requires a strong credit profile to qualify, and you’ll need to pay closing costs. You may also face higher interest in the form of a longer term or a higher rate if rates have risen since you took out your original mortgage.
• Reverse mortgage: For homeowners age 62 or older, a reverse mortgage, or Home Equity Conversion Mortgage (HECM), gives you access to cash while remaining in the home. You can choose to receive a lump sum, monthly payments, or a line of credit. You repay the reverse mortgage when you move out and/or sell the home.
• Home Equity Agreement/Home Equity Investment: A home equity agreement or home equity investment provides you with cash up front in exchange for a portion of your home’s value when you end the agreement. It’s not a loan, and you don’t need an excellent credit score to qualify. Unlock’s home equity agreement offers a way to access home equity without monthly payments. This could be a good option for homeowners who don’t want another monthly obligation or want to reserve that cash for something like starting a business.

Is a Second Mortgage Right for You?

To decide whether a second mortgage is the right solution, ask yourself a few key questions.

• How much equity do I have?
• Can I comfortably afford an additional monthly payment?
• What is the purpose of the funds — and does the cost justify it?
• Would an alternative like an HEA better suit my situation?

A second mortgage is best for people who:

• Have substantial equity built up in their home
• Have a specific purpose in mind for the funds
• Want to keep their existing first mortgage (because it has a super-low interest rate, for instance)
• Have good credit and a stable income to qualify for a low interest rate

If one or more of those don’t match up with your situation, an alternative such as a home equity agreement could be the better choice for your needs.

Conclusion

Second mortgages provide a useful way to access your home equity for a wide range of uses, from consolidating debt to paying college tuition bills. Home equity loans and HELOCs are the most common types of second mortgages, allowing you to choose between fixed payments and interest rates or a revolving line of credit with a variable rate.

However, since second mortgages are subordinate to first mortgages and therefore a greater risk for the lender, their interest rates are higher, too. Carefully consider the pros and cons of a second mortgage, explore alternatives like a home equity agreement, and run the numbers yourself before choosing the best path forward.