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 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. These include:
- What is a second lien?
- What are the advantages and disadvantages of a second lien?
- When should you get a second lien?
- Where can you get a second lien?
Let’s dive in!
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 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? Think of it as a home equity loan. 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 Advantages and Disadvantages of a Second Lien?
As with any form of financing, some benefits and trade-offs come with taking out a second mortgage. If you’re considering a second lien, weigh the pros and cons to help determine if it’s right for you.
- A Large Loan. Because you’re securing the loan with your home as collateral, you can take out a more substantial amount of money than you’d be able to through other means.
- Possible Tax Deductions. Laws have recently changed that have made qualifying for a mortgage interest tax deduction a little harder, but you still may be eligible in some cases. You’ll want to check with a tax professional before basing your decision on the tax deduction, but in many cases, you can use the deduction if the money is used to build, buy, or add “substantial improvements” to your home.
- Good Interest Rate. Even if second liens have a higher interest rate than first liens, they typically still have a better interest rate than other kinds of debt, such as credit card debt. These rates can make it a viable option if you’re looking to consolidate expensive debt and reduce interest rates.
- Increasing Your Debt Burden. Using home equity to pay other loans and debts doesn’t equal paying off debts. Any time you take out a loan with your home as collateral, you risk foreclosure if something should happen to your income flow.
- Losing Equity. You gain equity in your home as you pay off your mortgage, but if you borrow against your house, that equity can quickly be wiped out.
- Fees. Be prepared to pay all of the typical fees associated with taking out a loan like origination fees, credit checks, closing costs, etc. Expenses like this can add up and potentially cancel out any savings from lower interest rates.
When Should You Get a Second Lien?
People take out second mortgages for a variety of reasons. Some of the most common causes include home improvements, debt consolidation, or funding education. Sometimes it’s worthwhile to take on riskier debt if it will go toward something that will improve your home’s worth in the long run or set you up for success later down the line. If you plan on taking your family on vacation using the money from a second lien, you might want to rethink the decision.
Above all, do the math.
It may look like you’ll save a few thousand by paying off debt from second mortgage money, but make sure you do the math before making a decision. In some cases, you may save some money in interest rates but end up paying more due to fees, closing costs, etc. And don’t forget to weigh the potential risk of foreclosure in your decision.
Where Can You Get a Second Lien?
If you’re looking for second lien lenders in Texas, start with your local credit unions or banks. Member-owned credit unions often have competitive interest rates, along with several other benefits. You can also enlist the help of a mortgage broker or search online for reasonable rates.
A second lien loan is a good option for some, but it isn’t for everyone. It can provide much-needed funds to undertake projects like home renovations or pay off high-interest credit card debt. But like you should with any other significant financial decision, it’s always important to compare the advantages and disadvantages, as well as assess the risk involved in your particular situation.