Should You Get a Second Home Equity Loan? A Complete Guide

Taking out a second mortgage or home equity loan can give you access to the cash tied up in your home’s equity But is getting a second home equity loan the right move for you?

In this comprehensive guide, we’ll explain everything you need to know about second home equity loans, including:

• What is a second home equity loan?
• How does it differ from a HELOC?
• What are the pros and cons?
• What factors determine your eligibility?
• How much can you borrow?
• What are the costs?
• Tips for getting the best rates and terms

So if you’re wondering whether tapping into your home’s equity again makes sense read on for the full scoop!

What Exactly is a Second Home Equity Loan?

A second home equity loan is simply a second mortgage taken out against a property that already has an existing mortgage.

The first mortgage loan you get when purchasing a home is considered your “first lien” on the property. Any other loans taken after that are considered second, third, and so on mortgages.

Home equity loans allow you to borrow against the equity – the difference between your home’s market value and how much you owe on your first mortgage – that you’ve built up in your property.

The proceeds from a home equity loan can be used for any purpose. Common uses include:

• Home improvements and renovations
• Consolidating high-interest debt
• Funding college tuition
• Financing a wedding or other major life event
• Making a large purchase
• Serving as a source of emergency funds
• Buying a second home or investment property

Second Mortgage vs. HELOC: Key Differences

While both tap into your home’s equity, there are some important distinctions between a second mortgage and a home equity line of credit (HELOC):

Payment Structure

• Second Mortgage: You receive the funds in a lump-sum payment and repay the loan with fixed monthly payments over a set term, usually between 5-30 years.

• HELOC: This functions like a credit card, giving you access to a revolving line of credit you can draw on and repay on a flexible schedule. You only pay interest on what you actually use.

Interest Rate

• Second Mortgage: Has a fixed interest rate locked in for the life of the loan. This allows you to precisely calculate your monthly payments.

• HELOC: Typically comes with a variable rate tied to an index like the prime rate. So your payments will fluctuate along with interest rate changes.

Access to Funds

• Second Mortgage: You get the full loan amount upfront in a single disbursement.

• HELOC: Lets you access funds as needed for a set draw period, usually 10 years. This offers more flexibility if you have ongoing or intermittent borrowing needs.

Repayment Term

• Second Mortgage: Repaid over a pre-set installment term ranging from 5-30 years.

• HELOC: Has an interest-only payment period while the line is open. Then converts to a repayment period, usually over 15-20 years.

The Pros and Cons of a Second Home Equity Loan

Second mortgages offer homeowners a way to tap equity they’ve built for any purpose. But like any loan, they also come with drawbacks. Let’s look at the key upsides and downsides.

Potential Benefits

• Access substantial funds. You can tap into a significant pool of funds at competitive rates compared to other financing options.

• Use the money for any purpose. Unlike your first mortgage, a second home equity loan’s proceeds aren’t restricted to a specific use like purchasing a property.

• Consolidate high-interest debt. You can roll multiple debts like credit cards or personal loans into a second mortgage at a lower rate.

• Make home improvements. Fund major renovations or upgrades to increase your property value.

• Preserve your first mortgage. You can access equity without refinancing your original low-rate mortgage.

• Interest may be tax deductible. You can likely deduct the interest if the loan is used to substantially improve your home.

Potential Drawbacks

• Closing costs. You’ll pay lender fees, appraisal fees, and other closing costs much like when originating a mortgage.

• Your home is at risk. If you default, the lender can foreclose on your property.

• Variable rates. A HELOC’s fluctuating rate may rise and lead to higher payments down the road.

• Predatory lending. Unsavory lenders may steer borrowers into risky, expensive loans that jeopardize their financial health. Be vigilant.

• Temptation to overspend. Having substantial equity loans available could lead some borrowers to overspend.

As you can see, second mortgages aren’t necessarily an automatic slam dunk. Make sure you carefully weigh the potential rewards against the risks before moving forward.

What Factors Determine Your Eligibility?

If you’re considering a second home equity loan, there are a few key criteria lenders will evaluate to determine if you qualify:

• Credit score. Most lenders require a minimum score in the mid 600s, though the exact threshold varies. The higher your score, the better the rate you can expect.

• Loan-to-value (LTV) ratio. This compares how much you want to borrow to your home’s value. Lenders typically require at least 15% home equity but may allow higher LTVs.

• Debt-to-income (DTI) ratio. Lenders look at your total monthly debt payments divided by gross monthly income. 43% or lower is ideal, though some allow higher.

• Home appraisal. The lender will order a home appraisal to establish current market value and how much equity you have available to tap.

• Existing mortgage status. Most require your first mortgage to be in good standing with on-time payments.

As long as you meet the lender’s criteria, you should be able to qualify for a second home equity loan or HELOC. Shop around with multiple lenders to find the best rates and terms.

How Much Money Can You Borrow Against Your Home Equity?

The amount you can borrow with a second mortgage depends on:

• Your home’s current market value

• How much you still owe on your existing mortgage

• The loan-to-value (LTV) ratio the lender allows

For example:

• Your home is worth $400,000
• You owe $200,000 on your first mortgage
• You have $200,000 in equity
• The lender permits borrowing up to 85% LTV

In this scenario, you could qualify for a second mortgage of up to $170,000 (85% of $200,000).

Some lenders may allow you to tap 90-100% of your home equity. But borrowing to the hilt leaves you little cushion if property values decline. Aim to preserve at least 20% equity if possible.

What Are the Costs Associated With a Second Mortgage?

As with any loan, you’ll incur some upfront fees and closing costs when taking out a second mortgage, including:

• Origination fee – Up to 1% of the loan amount

• Appraisal fee – $300-$500 typically

• Credit report fee – $25-$50

• Application fee – $75-$100

• Title search fees – $100-$200

• Recording fees – Varies by state, often $50-$150

• Attorney fees – $300-$1,000 or more if you hire your own lawyer

You may be able to roll these costs into your loan amount. But doing so increases the total interest you pay over the life of the loan. Shop around for lenders offering deals on closing costs.

5 Tips for Getting the Best Second Mortgage Rate & Terms

Follow these tips to make sure you get the most competitive deal on a second home equity loan or HELOC:

1. Shop with multiple lenders – Compare quotes from banks, credit unions, mortgage lenders, and online lenders. Avoid settling for the first offer.

2. Negotiate – Once you have competing quotes, negotiate with lenders to see if they’ll beat the best offer. Leverage competition to your advantage.

3. Check for deals on fees – Some lenders waive or discount origination fees, appraisal fees, and other closing costs for a limited time. Time your application accordingly.

4. Boost your credit score – Work on improving your credit before applying. Even a small score bump can mean a lower rate.

5. Consider a shorter term – Opting for a 10 or 15-year term rather than 30 years reduces the interest you pay over the life of the loan.

With some savvy shopping and negotiation, you should be able to secure highly competitive rates, fees, and terms on a second mortgage. Take your time an