If you’re trying to pay down high-interest debt or need to make major home repairs, a second mortgage may be right for you. Here’s what you need to consider:
What’s a second mortgage?
A second mortgage is a loan taken against the equity you’ve built up on your home since you signed your first mortgage. There are two common forms:
- Home equity lines of credit work like credit cards by allowing you to borrow up to a pre-set limit. You repay it by making flexible payments with interest.
- Home equity loans work similarly to first mortgages in that you borrow a fixed amount and make fixed monthly payments with interest.
The main advantage of a second mortgage is that it usually has a much lower interest rate than credit cards and unsecured loans. The downside is that because it’s secured with your home, you could potentially lose your home if you can’t keep up with your payments. Also, note that beginning in 2018, second mortgage interest is only tax deductible if used to buy, build or substantially improve your home.
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What happens if you want to sell your home?
If you want to sell your home, the process works similarly to any other mortgage. At closing, you will need to use the proceeds of the sale to pay off both the first and second mortgages.
If you’re underwater (have a balance that exceeds the current market value of the loan), you’ll need to cover any additional amount with cash or by making alternative borrowing arrangements.
What happens if you want to refinance your first mortgage?
You can refinance your first mortgage while you have a second mortgage, but there’s a catch. Mortgage lenders get priority over your home based on when their mortgage was filed. For example, your first mortgage lender gets paid first in foreclosure because their mortgage was issued first.
During a refinance, your second mortgage would become your oldest mortgage while your new “first” mortgage would no longer be first. To keep their place in line, the lender for your refinanced mortgage will usually require that your second mortgage lender sign a subordination agreement stating that the refinanced mortgage takes priority over the second mortgage.
What happens if you don’t pay your second mortgage?
If you don’t pay your second mortgage, the bank has the right to foreclose on your home to pay the outstanding balance. During a foreclosure, the proceeds from the sale of your home first cover your first mortgage, then any remaining amount covers your second mortgage, and then any remaining amount after that goes to you.
If your second mortgage lender believes that the sale won’t cover what they’re owed, they may choose to sue you personally rather than initiating a foreclosure. This may result in the lender gaining access to your cash assets or securing a judgment against you.
Is it possible to avoid a foreclosure?
If you’re struggling to make your payments, it may be possible to avoid a foreclosure. Your first option is to settle the debt or to negotiate for a new payment plan.
A short sale may also be a possibility, but if you’re upside down on both your first and second mortgages, you’ll need to get both the first and second lenders to agree to split the proceeds of the sale. The first lender will often hesitate as they would normally have priority over the second lender, but they may decide it’s in their best interest versus going through the foreclosure process.
Also, remember that either lender can sue you for any balance not covered by a short sale or other repayment arrangements unless they agree otherwise in writing.
Talk to a lawyer
If you’re considering a second mortgage or facing foreclosure, ask a Real Estate lawyer a question to learn more about the legal implications of a second mortgage and how they affect your rights.