What is a Second Mortgage & How Does It Work?

May 18, 2020

When bills are starting to pile up and you've already maxed out the credit cards, it makes sense to look to your most valuable asset — your home. Millions of homeowners throughout the nation have invested in owning their homes, but are still finding themselves struggling financially.

If you're falling behind on your mortgage, you may not realize that you are able to utilize the cash that’s tied up in the equity of your home. However, there are many options to consider when you need to tap into the value of your real estate investment. 

It's not always the best market to sell your property, and you might not be ready to move. Some homeowners can benefit from programs like EasyKnock's Sell & Stay, where EasyKnock buys your home and rents it back to you, allowing you to gain access to your cash without having to move. Others may be considering a home equity loan or a HELOC, which stands for "home equity line of credit." Both of these are examples of second mortgages.

What is a second mortgage? It is a separate and secondary loan that allows you to borrow money against a percentage of a home value that has appreciated over the years. If your home is worth $100,000 and you only owe $40,000 on it, you may be able to borrow against the $60,000 of remaining equity. This allows you to receive cash without having to move. While it may seem like a great solution to a tight financial situation, there are three important things you should know before moving forward.

Things to Consider Before Taking Out a Second Mortgage

1. You Are Still Responsible for Paying Your First Mortgage

When you are considering a second mortgage, chances are you are working with a different company than the one that previously gave you a mortgage to purchase your home in the first place. A second mortgage does not replace your first mortgage. Instead, you will be responsible for paying off both loans.

Second mortgages are secondary because your original loan is the one that will be repaid first if you lose your home to foreclosure and the bank auctions it. However, if that sale price does not cover the amount you owe on both mortgages, you will still be financially responsible for the remainder. 

Second mortgages often feature a lower interest rate than other loans, so it can be a good alternative compared to applying for a high-interest credit card. But other alternative programs, such as those offered by EasyKnock, can provide the capital you need to avoid foreclosure.

2. The Market May Impact Your Ability to Pay a Second Mortgage When You Sell

Companies that offer second mortgages know you are taking a risk. Your home equity isn't realized until you sell your property at market value. It is possible that the market will change between receipt of your second mortgage and the eventual sale of your home. Your equity could decrease. Just because your home is lower in value does not mean that you won't have to pay back all of your loans.

Perhaps you were previously able to pay a little extra on your first mortgage each month. This helped to increase your equity. Your equity also increases during a strong real estate market, known as a "seller's market." However, when the value of your home decreases, you'll lose equity. In reality, you are taking the money out of an investment before you know exactly what the dividends will be.

3. A Second Mortgage Can Be a HELOC or a Home Equity Loan

Second mortgages usually come in two forms. You can either receive cash for your equity as a lump sum or as a line of credit. This is the difference between a home equity loan and a HELOC to pay off a mortgage or other bills. 

With the home equity loan, you will receive all the cash at once. Then, you will be responsible for paying the loan back within the agreed-upon terms. This usually means fixed payments spread out over a set number of years. Just like your first mortgage, you will pay a portion of interest along with a portion toward the principle of the loan. Check your terms to see the amortization rate.

A HELOC, meanwhile, provides you with access to an account that you can draw from as needed. There are normally specified borrowing limits. It is similar to a credit card that you can pay back and make withdrawals from when you wish.

Some loans have fixed interest, while others have variable interest rates. Read the fine print closely when considering a second mortgage, as you’ll want to make sure you're able to pay what is required so you can keep your real estate investment secure.

Create a Budget to Avoid Pitfalls

Remember, you'll also be responsible for the costs that are associated with your second mortgage, just like you were with your first one. That can mean paying for an appraisal, origination fees, credit checks, and other necessary costs. This is true even if the lender advertises that the second mortgage has "no closing costs." 

Often, homeowners who are considering second mortgages have found themselves in a tight financial position. This may be because they are unable to get a line of credit from a bank, are divorcing, or are at risk of losing their home. You can pay for your first mortgage with your second mortgage, but it's important to take additional steps to protect your financial future.

Financial experts encourage homeowners to create a personal or family budget to ensure that there is enough money to pay your debts every month. It can be difficult to cut costs for enjoyable activities like eating out or buying new clothes. If you don't wish to do that, you'll need to find additional streams of income to pay for your second mortgage. 

Companies that offer the ability to stay in your home while alleviating debt can be a great mortgage alternative. It's important to consider all of your options, such as EasyKnock’s Sell and Stay program, before undertaking additional debt that will leave you more financially vulnerable than before. 

Choosing the best solution for your circumstance will help you get back on your feet and create a stable financial foundation upon which you and your family can grow and thrive.