Second mortgage loan is a term that is used interchangeably with the term “home equity loan” these days. A second mortgage is a loan taken out on your home and secured by the amount of equity you have gained in the house, either through paying down a portion of the principal or through increased valuation in the housing market. Technically, home equity loans can also be provided as home equity lines of credit (HELOCs) but the home equity loan is usually a lump sum – and therefore the same thing as a second mortgage.
Second mortgages have become popular over the last five years with the steep rise in home values. Many people have chosen to turn recently realized home equity into cash through the use of a second mortgage loan. These loans are often shorter than the primary mortgage – usually five to fifteen years in duration. A second mortgage is usually, though not always, provided as an adjustable rate mortgage (ARM). HELOCs are always adjustable rate loans.
Generally, the interest rate on a second mortgage is going to be two to three percent points higher than the available rate on a thirty year primary mortgage. One of the reasons for the higher interest rate is the shorter life of the loan. The other is that a second mortgage loan is subordinate to the primary mortgage on the house.
What this means is that, should the home go into foreclosure and be sold, it is the lender on the primary mortgage who gets paid first. According to real estate law, the primary lender may collect the entire principal owed as well as all the remaining interest and any foreclosure costs. The lender on the second mortgage loan is then paid from whatever remains.
Many lenders will limit the amount of the second mortgage based on what is currently owed on the first mortgage and how much the property is worth on the current housing market. The limit on total mortgage debt is capped at 80% of the home’s worth. This means that what you owe on the first mortgage and the amount of the second mortgage can add up to a maximum of 80% of the home’s current value.
If, for instance, you own a house that is appraised at $350,000 and you owe $250,000 on your primary mortgage, then you hold $100,000 in equity in the home. However the maximum your lender will allow is 80% total debt against the home’s value. Since 80% of $350,000 is $280,000 and you owe $250,000 on the first mortgage, you are eligible for a second mortgage in the amount of $30,000.