A home may have multiple mortgages on it. Second mortgages are subordinate, meaning that in the event of default, the primary, or first mortgage would get paid off first, and then any funds remaining would be used to pay off any second mortgages. For this reason, second mortgages typically carry a higher rate of interest. Also, like first mortgages, second mortgages also carry closing costs and "points" that may make the total cost of the second mortgage more expensive.
In the most common type of second mortgage, a homeowner may borrow up to the amount of equity he or she has in the home. For example, if the owner has a home valued at $100,000 and currently owes $75,000 on the first mortgage, a second could be taken out for $25,000. Because this type of second is still 100 percent secured by equity, it is the easiest type of second mortgage to get, and will not be as expensive as other second mortgages that are not fully secured.
There are actually several types of second mortgages. A line-of-credit second mortgage is one in which the homeowner does not take cash out immediately, but instead, applies for a line of credit secured against the home, which can be used as needed.
In some cases, a second mortgage is taken out at the same time as the first to help qualify for a new purchase. A borrower may, for example, qualify for a first mortgage that requires 30 percent down. If the borrower only has 20 percent, they may be able to take out a second mortgage for the additional 10 percent.
It is also possible to obtain a second mortgage in excess of your home's value. With a 125 percent loan-to-value loan, your total indebtedness can be 125 percent of the value of your home. This type of loan may be more difficult to obtain, and may require superior credit. A major disadvantage of this type of loan is that your interest will not be completely tax-deductible. Mortgage interest is allowed as a tax deduction only up to the amount secured by real estate.
The second mortgage is often an excellent option for obtaining needed cash, although in some circumstances, refinancing a first mortgage may be a better option. If the first mortgage was taken out when interest rates were high, refinancing the first mortgage will not only yield the needed cash, it will also very likely result in a much lower interest rate. When deciding between taking out a second mortgage and refinancing, consider what the transaction costs (closing costs) are, and investigate the relative interest rates. The results won't be the same for everybody. Whether refinancing or taking out a second mortgage yields the best bottom line will depend on your existing equity, credit rating, and other factors.