Second Mortgages

A second mortgage is a loan that sits subordinate to a first mortgage loan. This means that in a situation where a home is foreclosed on and liquidated, the proceeds from sale would first be used to pay off the first mortgage, and remaining proceeds would be used to pay off the second. Because of this, second mortgage lenders have a higher rate of loss than first mortgage lenders. Second mortgages have several characteristics that make them different than first mortgages.

Types of Second Mortgages

While all second mortgages are similar in that they sit subordinate to a first mortgage, there are several different types of second mortgages. One of the most common types of second mortgages is a piggy-back loan. A piggy-back loan is a mortgage that is used by a borrower to help finance the purchase of the home. In a piggy-back loan situation the borrower will receive a first mortgage for 80% of the purchase price and, if they have less than a 20% down payment, a piggy-back loan to finance the rest of the purchase. Typically, the piggy-back loan will be financed by the same lender as the first mortgage lender.

The second type of second mortgages is home equity loans and lines of credit. These second mortgages are secured by the borrower’s equity in the home. As opposed to piggy-back loans, which are used for the purchase of a home, home equity loans and lines of credit do not have any specific use.

Costs

Since second mortgages sit subordinate to first mortgages, they are considered higher credit risks to the bank. Because of this, the costs associated with a second mortgage are higher than a first mortgage. First, second mortgage rates tend to be higher than first mortgage rates. Many banks will also charge additional origination fees for second mortgages.

Other factors could also influence 2nd mortgage rates. Like first mortgages, the rates paid for a 2nd mortgage will be higher if the borrower has less equity in their home, has a poor credit history, or does not have a reliable source of income.

Repayment Requirements

The way that a second mortgage is repaid varies from loan to loan. Typically, a piggy-back loan has a long repayment term, ranging from 15 to 30 years. The borrower will usually submit a monthly principal and interest payment. In some situations, a piggy-back loan may have a 15-year term, but 30-year amortization which would require a balloon payment after the 15-year term matures.

A home equity loan or line of credit typically has a much shorter term, which ranges from one to five years. Home equity loans typically require principal and interest payments, which would result in a payoff by maturity. Home equity lines of credit only require monthly interest payments and any outstanding balance at loan maturity will result in a balloon payment.