The world of home financing can be confusing enough without throwing additional loans and liens on top of existing mortgages. If the idea of a second lien mortgage leaves you with more than a few questions, you’ve come to the right place. We’ll tackle the ins and outs of second liens, lenders in Texas, and the most important things to keep in mind when researching a second mortgage.
What Is a Second Lien?
A second lien is a loan taken out that uses your home as collateral, even though you already have a mortgage that is secured by the property. It comes second to the first lien, which is the initial mortgage you took out to purchase the home.
These loans can go by many names— a second mortgage, second (2nd) lien loan, and junior lien, to name a few— but they all refer to a second loan borrowed against the value of your home.
That being said, it’s also important to note that the phrase ‘second lien’ doesn’t only refer to the order in which you take out the loan. It also refers to the position of the lien. Your initial mortgage usually takes the first position, which means that if you can no longer make payments sell your home, you pay off that loan first. The second lien will be paid off after.
Because the order in which you secure mortgages will determine their payout, there’s always a chance that the sale of a home won’t cover both loan amounts. As a result, lenders will often mitigate their exposure by offering second liens with higher interest rates than first liens.
Common Second Liens
Second liens come in many forms. Some of the most common include:
- Home Equity Line of Credit (HELOC). These are typically adjustable-rate “open-end” loans. With a home equity line of credit, you borrow against the equity you have in your home, and, similar to a credit card, you can take out the money as you need it.
- There’s a maximum loan amount that you can take out, but you aren’t obligated to take the entire amount. Also, similar to a credit card, you can pay down the balance as you use it.
- Home Equity Loan. Unlike a home equity line of credit, a home equity loan is disbursed in one lump sum. With this closed-end loan, you’ll receive the entire loan amount upfront and will not be able to withdraw more after the initial disbursement.
Second Mortgage vs. Refinancing
What is the difference between a second mortgage and refinancing your existing mortgage? When refinancing, you take out another mortgage, often with a better interest rate or a more desirable term, to pay off the initial one. By comparison, a second mortgage replaces the first one instead of having two mortgages out at one time, as you would with a second mortgage.
What Are the Pros and Cons of Subordinate Financing?
Subordinate financing can come in handy in a variety of situations, from downpayment assistance to cash to complete home renovation projects. But like most things in the financing world, it is not without its fair share of drawbacks.
- Can Help You Avoid Jumbo Mortgages. Traditional conforming loans cap at $510,400 for all Texas counties. If you need a more substantial mortgage than that, you’ll likely have to take out a jumbo mortgage. Homeowners may choose to take out one conforming loan and one smaller subordinate loan to split the amount into two.
- Avoid Paying Private Mortgage Insurance (PMI). In most cases, lenders will require private mortgage insurance if less than 20% is placed down on a home purchase. Subordinate financing can be used to put down a larger down payment, therefore eliminating the need to pay for PMI.
- Receive Cash for Home Renovations and More. Loans borrowed against your home’s equity provide you with money that you can use at your discretion. While there is some risk of abuse with this product, it can be used to complete home renovations, which increases a home’s value. Another common use of these funds is debt consolidation and higher education expenses.
- Better Interest Rates Than Other Forms of Borrowing. Compared to different types of borrowing like credit cards, subordinate financing offers more affordable interest rates.
- Tax Deductions on Mortgage Interest. In some cases, you can take advantage of a tax deduction on mortgage interest, which helps your wallet during tax season. However, laws around this have recently changed, so be sure to consult a tax professional to ensure you’re eligible.
- Increasing Your Debt Burden. You always have to be careful when you grow your debt burden, especially when it is secured against your home. As with your mortgage, this puts you at risk of foreclosure should something prevent you from being able to make payments. An increased debt burden makes subordinate financing riskier than some of the other ways to borrow.
- Multiple Loan Payments. With subordinate financing, you pay both home loans off concurrently. Two payments mean you’ll have two bills every month, which can be costly as well as a hassle.
- Higher Interest Than the Senior Mortgage. Because of the greater risk that financial institutions carry with a subordinate loan, they typically have a slightly higher interest rate than primary home mortgages.
- Unwise Spending. While cash in hand can be used for worthwhile projects, it can also be spent unwisely and end up costing you. Remember that you are still paying interest on these funds and should not treat this as free money.
When Should I Utilize Subordinate Financing?
There are all sorts of situations where subordinate financing is appropriate. If you’re looking to take out a subordinate loan, there’s a number of channels you can go through. Credit unions, for example, offer competitive interest rates and can be a helpful resource in guiding you through the world of home financing.
But like any big choice, a finance decision needs to be thought through. Weigh the advantages and disadvantages of your particular financial situation. Ask yourself if the benefit is greater than the inherent risk that second mortgages carry. Do your research, and you may decide that subordinate financing is right for you.