What is a Second Mortgage?

If you're in the market for a home, you might have a few questions about the ins and outs of the mortgage world. Here at MomVesting, we've covered some basic mortgage topics already, but we have not yet tackled the second mortgage. So let's take a look at this sometimes integral portion of the home-buying process.

Open-Ended and Closed-End Loans

Before we talk about the second mortgage portion of your mortgage package, let's set a little groundwork with a few definitions: the open-ended loan and the closed-end loan. These two terms define the types of loan you can receive at your bank or credit union, and they'll help define the second mortgage in a little while.

An open-ended loan, also known as a revolving line of credit (LOC), is any loan where you draw upon a predetermined amount of cash, up to your max loan amount. In this type of loan, the credit is said to be open-ended because it is basically open to you for multiple draws (or multiple loans). As long as you keep making payments and don't go over the total loan amount on any of your draws, you are able to continuously draw from the available credit as you see fit. This is similar to a credit card.

In a closed-end loan, you agree to a certain amount of money at the beginning of the loan, and you cannot request more money as you go. The amount of credit is closed to you in this traditional loan type; you cannot change the terms at any time without refinancing the entire loan. This is similar to a fist mortgage or car loan.

A Second Mortgage as an Open-Ended or Closed-End Loan

Oftentimes, a second mortgage is taken as an open-ended line of credit called a home equity line of credit (HELOC). This practice is often favored because it allows homeowners to draw upon the equity of their home to make home improvements or use the funds in an emergency.

Another option, though, is available, particularly when purchasing the home. A closed-ended second mortgage may make it possible for a home buyer to purchase the house when they do not have 80% down payment. In this case, the bank will allow the borrower to take out a first mortgage at 80% and a second mortgage at a certain percentage (this percentage depends on the bank).

However, some banks will allow future homeowners to combine both second mortgage types into one loan, allowing the borrower to take on a portion of the second mortgage as an open-ended loan and the remaining portion as a closed-end loan. This helps when the homebuyers would like a line of credit in the future but cannot qualify for a large line at the time of the home purchase.

What Else Should I Know?

Closed-end and open-ended loans also come with different terms and conditions. Often, the closed-end second mortgage is less expensive than the open-ended; the interest rate is often lower on the traditional closed-end loan than on an open-ended.

Also, your repayment options will vary by loan. In a closed-end, you will typically be given a set payment amount over a set period of time, like $200 a month for ten years. Open-ended lines of credit will vary in minimum repayment amounts depending on the amount of money that you've used on the line, just like a credit card. For example, if you have used $10,000 of your LOC, your minimum payment due would be less than if you'd racked up $20,000.

One word of caution: just because the bank may allow you to take a second mortgage, it is not always advisable. Preferably, first-time homebuyers would put down 20% of their own money; it's much more secure to keep your repayments at a minimum.

Whew! There you have it: your basic second mortgage knowledge. Your actual second mortgage may have different terms and conditions, so it is wise to know all the details before you sign. But this should get you started!

Photo Source