Second Mortgages: How They Work, Advantages and Disadvantages

Homeowners in the United States may borrow up to 5.4 trillion in home equity loans. A home equity loan allows debtors to pay miscellaneous fees, vehicle repairs, home repairs and may be used to purchase other commodities. A home equity loan is a very attractive option for homeowners that want to apply for credit. A home equity loan otherwise known as a second mortgage allows homeowners to borrow money at low interests rates.

Second mortgages can be very helpful in emergencies, however, you may be wondering how much you should request. The amount that you may request will depend on what you need the money for, whether you need a full amount, your ability to repay a loan, the life of the loan, and how much you have already paid off to your first mortgage.

Just because we can take out a loan doesn’t mean we should even if the interest rate is low. Homeowners must understand that a second mortgage is a lien on their property. When you fail to make payments to your second mortgage, your mortgage loan provider can file a lawsuit and claim payment. In the worst of cases, homeowners that are unable to pay back their second mortgage may risk losing their home.

Can I apply for a second mortgage?

You can apply for a second mortgage if 1) you are the owner of your house (it means that you signed the paperwork for a first mortgage), 2) if you have equity on your property. To apply for a second mortgage you have to be the owner of the house, you cannot apply for a second mortgage if you are a renter.

In addition, you must have equity to use as collateral for a second mortgage. When you first apply for a mortgage loan, you will be required to make a down payment before you receive the loan. The mortgage lender will keep the first 20% of the first equity payments which means you cannot use this equity to apply for a second mortgage. It’s not a matter of how long you need to wait to apply for a second mortgage, it's how much equity you own on your property. For instance, if you made a 50 percent down payment at the time you took out a mortgage loan, then you may apply for a second mortgage with the 30 percent equity on the property.

Example: Billy bought a house for $200,000. He made a $100,000 down payment (50% of the value of his property), he may access 30 percent of his equity for a second mortgage assuming he request a second mortgage after making an initial down payment. Billy would be able to request a percent of $30,000 through a second mortgage. Reminder: lenders will hold on to 20 percent of the first equity payments and cannot be used for a second mortgage.

How do I receive a second mortgage?

Homeowners that want to request a second mortgage will usually work with their mortgage loan providers. Mortgage loan providers may either be banks or other private credit companies. When you request a second mortgage you may either request a line of credit or a lump sum loan. The type of the second mortgage you request will depend on your specific economic situation and overall goals.

Lump sum: you can receive the full amount of your loan in one payment. Homeowners that choose a lump sum will be required to pay back the loan at a fixed rate over a period of time. The loan will accumulate interest and the amount of interest will depend on how much you request. A lump sum is good for individuals that need the money for immediate emergencies or for investments that require lots of upfront capital. 

Homeowners Line of Credit (HELOC): a HELOC is a line of credit that functions similarly to other credit lines offered by banks. Homeowners may request a HELOC which allows them to draw from a pool of money and make payments as they go. The payments and the amount of interest that you will pay at the end of the credit line will depend on the amount you borrow at given times. A line of credit can be used for emergencies and does not have to be touched. Having a HELOC can be a good thing if you are responsible with your finances. The difference between a HELOC and a regular credit card is that if you fail to make a payment to your HELOC, you risk losing your home.

What is the relationship between my first and second mortgage?

When a person wants to buy a house, more often than not, they will apply for a mortgage loan to help with the upfront cost of buying a house. Through a mortgage loan, your property is used as collateral whenever you fail to repay your loan. For instance, when a homeowner fails to make payments to their mortgage loan, their mortgage loan provider may proceed with foreclosure. A foreclosure results in the auctioning of the property and the earnings are used to pay off your first or second mortgage. However, if you do not default on your payments and you are able to keep up with the mortgage, you may apply for a second mortgage.

After months of repaying a mortgage loan, your equity over your property increases. In other words, you own more of your house after every payment towards your loan. Homeowners may use the equity they have paid for overtime to establish a new credit line. For example, if Tim has paid off a $100,000 towards their mortgage, he may borrow a percent of what he has paid. Tim would be using his equity (whatever amount he has paid off on his home) to establish a new line of credit. Now Tim will have to pay off both his first and second mortgage, otherwise, he may lose his home.

What is equity?

The amount that a homeowner can request on a second mortgage will depend on their equity. In other words the more equity you have, the more you may be able to request for a loan or line of credit. The amount of equity you own changes over time depending on a variety of factors:

  • Your home increases in value. When your home increases in value, the amount of equity you own increases. Individuals that bought their house at or under market may own more equity if their property increases in value. A property can increase in value depending on the real estate market. In addition, a house increases in value when homeowners invest in additions to the house. Additions that can increase the value to your property can be adding a pool in your backyard, adding additional rooms, or investing in solar energy.
  • Making monthly payments. Homeowners that make monthly payments to their mortgage are paying off their estate and the interest of their loan all at the same time. Over a period of time of making payments, the homeowner will own more of his or her property. A mortgage loan can have a life of up to thirty years, so the longer you have been making payments, the more equity you own on your property.

In most cases, homeowners that make payments and invest in their property will own more of their property over a period of time. Homeowners with a good amount of equity can apply for a second mortgage loan with a low annual percent rate (APR).

What's the downside of a second mortgage? 

The downside to a second mortgage is that the equity you paid off over (x) amount of years is back under the chopping block. If you paid off more than sixty percent of your property, you may risk losing it all if you fail to pay back your second mortgage. A second mortgage is a lien on your property that can be claimed when homeowners fail to make the required monthly payments.

What is a second mortgage used for?

A second mortgage can be used for a variety of things. However, you should not consider a mortgage loan to pay off a credit line. When you pay an unsecured credit with secured credit, you risk losing the collateral if you cannot keep up with payments. In some cases, if you have a substantial amount of unsecured credit, you may want to speak with the credit provider to reduce monthly payments, to discharge some penalties, and other modifications that may help with your payments. On the other hand, you may pay off unsecured credit with other unsecured credit loans. If you have the ability to apply for a credit line with a low annual percent rate (APR) it may be a good idea to use this credit line to pay other credit lines with a high APR.

With that said, you can use a mortgage loan for an emergency repair or investment. Homeowners commonly request a second mortgage to make an addition to their home (adding value to their property), to pay an emergency medical bill, to buy another home, or to buy a vehicle. However, it is your credit line and you choose how you want to invest your money.

What happens if I cannot keep up with payments?

When homeowners are unable to make payments to their first or second mortgage they may face a lawsuit. A mortgage loan provider will not proceed with a foreclosure especially if you have not paid off a portion of your home. It is more likely for your mortgage loan provider to negotiate with you prior to proceeding with a foreclosure. In fact, under the Homeowner Bill of Rights, a mortgage loan provider is required to enter a negotiate before they proceed with a foreclosure. The less equity you have, the more likely it is for your loan provider to establish a loan modification program that works for you. If you have little to no equity on your property it means that the mortgage loan provider has more to lose when they proceed with a foreclosure. When a property is auctioned through a foreclosure, the mortgage loan provider will usually receive less pay than the original mortgage loan.

When you have equity in your home, mortgage loan providers will be more likely to proceed with a foreclosure. More equity means you paid off a portion of your mortgage loan and in turn, a foreclosure may allow a mortgage loaner to regain what they let you borrow. When your house is auctioned, it will usually be sold for less than the value of the mortgage loan so it makes more sense for a loan provider to wait until you paid back a portion of the loan before they can break even through a foreclosure.

In any case, a mortgage loan provider is required to negotiate with a homeowner before proceeding with a foreclosure. 

Foreclosure and bankruptcy

A foreclosure can be the outcome of failing to pay a second mortgage. If you receive notice of a foreclosure, you may want to speak with an attorney about ways you can avoid a foreclosure. As mentioned earlier, a mortgage loan provider is required to negotiate with the homeowner before proceeding with a foreclosure. A homeowner is able to fight a foreclosure by entering a loan modification program to establish lower monthly payments and provide a plan of repayment for any past due amount. 

In another instance, a homeowner that is facing tough economic times may prevent a foreclosure by filing a bankruptcy. If a homeowner wants to keep their property they should not file a Chapter 7 and should speak to their attorney about a Chapter 13 bankruptcy. Through a Chapter 13 bankruptcy, homeowners will be capable of creating a payment program that includes payments to their mortgage or second mortgages. A Chapter 13 allows a debtor or homeowner to get back on their feet without losing any property.

If you are being affected by a second mortgage and you find that you cannot make payments, you may want to speak with an attorney about debt relief. There are many ways that you can deal with debt, a bankruptcy is not always the right option. To have a better understanding of your case, you may contact the Bankruptcy Attorney at 424-285-5525.