Second Mortgage

A second mortgage is a mortgage for property that is already used as collateral for another mortgage. The second mortgage is always subordinate to the first. There is often confusion between second mortgages and home equity loans, although the two are distinctly different products. A home equity loan is defined as a mortgage, the proceeds of which are used for another purpose other than purchasing the home; for example, for paying off credit card debts, taking a vacation, or paying for school tuition.

A second mortgage may be advantageous, but there are several circumstances that must be taken into account, not the least of which is the deductible nature of the interest.

Interest payments paid on second mortgages are usually tax-deductible, but there may be some circumstances where they are not. Tax regulations state that to qualify for a deduction the second cannot exceed $100,000 plus the value of improvements. Also, if the funds are used to buy securities that generate tax-free income, interest cannot be deducted. Also, the combined value of both first and second mortgage cannot exceed the home’s value.

Other factors include the relative benefit of the second mortgage, compared to other scenarios, such as a cash-out refinance, requirements for mortgage insurance, amount of cash required, and how long you plan to stay in your home. For borrowers who purchased their homes at interest rates that are below the current market level, taking a second mortgage is often better than refinancing.

A second mortgage may be used as a way to avoid having to pay mortgage insurance on the first mortgage. Individuals may use a second mortgage when purchasing an expensive home, since jumbo loans often carry higher interest rates than conforming loans. Also, people who do not have 20 percent for a down payment, and would therefore be required to purchase mortgage insurance, can avoid this requirement by structuring an 80-10-10 loan.

This type of loan structure lets you purchase a home with a ten percent down payment. In this plan, you take out two loans; an 80 percent loan; and a second for ten percent. The second has a higher interest rate, but the monthly total of the two mortgages is often lower than the amount you would pay with just one mortgage with mortgage insurance.