Question: How Do We Get a Second Mortgage?
A reader asks: "My wife and were thinking about buying a bigger home because we just discovered that we are pregnant. This will be our fourth baby. We really need something bigger than 2 bedrooms and a den. My father-in-law says we should add a second floor to our existing home by getting a second mortgage. But I've heard banks don't make second mortgages anymore. How do we get a second mortgage? What does getting a second mortgage entail?"
Answer: Prior to the boon years of the late 1990s and early 2000s, almost anybody could get a second mortgage. Many home buyers obtained a second mortgage to help them buy a home. Typically these were piggyback loans, consisting of an 80% first mortgage and a 20% second mortgage.
Those loans have vanished. But it doesn't mean a home owner can't get a second mortgage. However, most lenders want to see that a home has equity before the lender will make a second mortgage. In the old days, when a person could qualify by fogging a mirror, a borrower could get a second mortgage up to 100% of the home's market value, and sometimes for more than that. Today, banks want tangible security, backed by solid equity, for that loan.
What is a Second Mortgage?
A second mortgage is junior in position to an existing first mortgage. Instead of refinancing a first mortgage by replacing it with a higher mortgage, a borrower may prefer to take out a smaller second mortgage.
For example, let's say your home is worth $200,000. You owe $120,000 on a first mortgage. A bank might use the 80% rule and say you are eligible, if your credit scores are good enough, to finance 80% of $200,000 or $160,000.
After subtracting your first mortgage of $120,000, you may be able to borrow $40,000 on a second mortgage. The second mortgage is then recorded in the public records and becomes a lien against your home.
Reasons to Get a Second Mortgage
The interest rate and repayment schedule may be more favorable on a second mortgage than refinancing your existing first mortgage into a larger loan. For example, if your $120,000 mortgage is payable at 6.5%, your second mortgage might be available at a lower rate, perhaps 5% or less, depending on fluctuations in the market place.
Moreover, the costs to obtain a $40,000 loan may be very small in comparison to the costs to obtain a $160,000 loan. Some second mortgages do not cost the borrower any upfront money at all -- there may be no closing costs.
What Can You Do With the Money From a Second Mortgage?
A lender will ask on your loan application why you want to get a second mortgage. You might think it's none of the lender's business what you do with your money, but the lenders don't agree with you. Here are reasons a lender might consider:
- Home remodeling / additions
- Home improvements
- Emergency medical
- Reliable investments
- Care for dependants
- Debt consolidation, if it makes sense
Lenders aren't too thrilled to give you money to spend on depreciating assets or entertainment expenses, but it doesn't mean they won't.
At the time of writing, Elizabeth Weintraub, DRE # 00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.