Should You Take Out a Second Mortgage?

A home is a big investment. It’s also a big money eater. And while taking out just one mortgage is often stressful enough, many homeowners opt to take out a second mortgage later on to cover big expenses—including getting funds to put toward a high interest rate first mortgage.

Taking out a second mortgage, like taking out a first mortgage, isn’t something that should be pursued without plenty of research. Below, we’ll go over the basics of second mortgages to help guide your decision making, as well as share some of the advantages that might make it a good idea for you to take out a second mortgage. In addition to doing research here, we also recommend that you speak to a financial advisor who can help you determine whether alternate financing options might be a better fit for your needs.

What is a Second Mortgage?

A second mortgage is a loan secured by your home (another way to put this is that your home is your collateral on the loan—i.e. if you don’t pay back the loan, you don’t get to keep your home). It operates very similarly to a first mortgage, with the primary difference being that this is an additional mortgage on your home and not the sole loan on the property.

The amount that you can borrow when you take out a second mortgage depends on the equity you have in your home, as well as its market value. Remember: equity is the amount of principal you own in your home. This amount increases or decreases depending on how much you pay toward your mortgage each month and whether the home has increased in value, decreased in value, or maintained its value.

A second mortgage is a big lump sum payment, so homeowners generally take one out only for major expenses. These include:

• • Substantial home improvements, such as costly home repairs or renovations
  • Tuition costs
  • Debt consolidation
  • Putting more money toward a high interest first mortgage and/or a first mortgage with a PMI (private mortgage insurance)

  Note that a second mortgage is subordinate to a first mortgage. This means that if you default on both of your loans, it’s your original mortgage lender who will have first dibs on sale or foreclosure proceeds. That makes a second mortgage a riskier endeavor for lenders, and explains why you might face higher interest rates than you did the first time around.

  Second Mortgage vs. Cash Out Refinancing

  If all of this is sounding familiar, then it might be because you’ve heard of other loan options that use your home as collateral, including cash out refinancing. The main difference between a second mortgage and a cash out refinance is that while both allow you to borrow money using the equity you own in your home, a second mortgage creates an additional mortgage that exists alongside your first one, whereas a cash out refinance replaces your first mortgage with a new one.

  Why then might you choose to take out a second mortgage instead of just creating a new one? If mortgage rates have gone up, you’ll probably be better off taking out a smaller second mortgage to cover just what you need, instead of refinancing at a higher interest rate. Taking out less money also means lower closing costs, which is a good short term win.

  Second Mortgage vs. Home Equity Line of Credit (HELOC)

  Another financing option you’ve probably heard of before is a home equity line of credit, or HELOC. With a HELOC, you again borrow money against the equity of your home, with a standard 10 year draw period during which you can take out funds from that amount, usually followed by 20 years for repayment. Like a second mortgage, this creates a loan that is in addition to your first loan as opposed to replacing it like you would with a cash out refinancing.

  As for choosing a second mortgage over a home equity line of credit, that again usually comes down to rates—though in a different sense than refinancing. Second mortgage interest rates are typically fixed, meaning what you agree to on the day you close is what you’ll be paying during the life of the loan. A home equity line of credit, however, usually has a variable interest rate that can (and often does) change over the course of the loan. If rates go up, you could end up paying more than you anticipated.

  Advantages of a Second Mortgage

  If you need a lot of funds—and fast—then a second mortgage is definitely an option worth considering. There are three big advantages to choosing to go this route:

  You can borrow a lot. If you need a lot of money for something like a major home improvement, then a second mortgage is a good way to get it. Unlike personal loans, which are often capped at a certain qualifying amount, a second mortgage borrowing limit is based off of how much equity you have in your home. And if you’ve been there for a while, then you should have a lot. You can usually borrow up to 80% of your home’s value, though the amount still owed on your first mortgage is taken into consideration.

  You might get some tax benefits. Depending on what you plan to take out a second mortgage for, you may be able to reap some tax benefits—for example, if you use the money toward certain energy efficient upgrades. Tax benefits aren’t a guarantee though, especially with the Tax Cuts and Jobs Act of 2023 (you can find a good explainer of that plan here), but it’s definitely worth talking to your tax preparer to see if your plans for your second mortgage warrant a tax break or two.

  You might get a lower interest rate than other financing options. A home has a lot of value, which makes it preferred security on a loan. And although it’s your first lender who has full claim to asset proceeds in the case of a default, having such strong collateral does still often mean you get a lower interest rate than you would with financing options that aren’t secured by your home.

  As for the disadvantages, all loans carry with them some risks that you have to balance with the rewards. And one of the biggest risks with a second mortgage is that you’ll have to make two mortgage payments every month instead of just one, which could stretch your budget thin and lead to foreclosure. You’ll also need to cover closing costs again, including things like credit checks and origination fees—which can add up fast.

  The best way to ensure that you make the smartest financial decision for getting the money that you need is to work with a qualified advisor who can look at your situation and evaluate it along with your various financing options.

  Be sure that in addition to doing your due diligence in terms of research you also shop around for the best terms. While your interest rate is largely based on your income and credit history, you’ll probably find different terms from lender to lender. Not sure where to start? Talk to your original mortgage broker. You can also talk to your realtor and get recommendations for a broker or loan originator.