Second mortgages have the reputation of being more difficult to obtain than a first mortgage or many other types of loans. However, in recent years mortgage lenders have become much more willing to allow homeowners to meet their financial needs by taking out a second mortgage. Each lender will have their own criteria for approving borrowers, but here are some likely steps for getting approved.
The lender will do a preliminary check on your credit rating, as well as determining whether you have sufficient income to make the loan an acceptable risk. Your employment history and banking record will also come into play. Make sure all relevant financial documents are up-to-date and easily accessible.
An important factor in the bank’s decision to approve you will be your home equity. Since a second mortgage is a secured loan, with your home as collateral, your lender will want to know that you are substantially the owner of that home. A home appraisal, usually at your own expense, may be requested by the lender in order to determine that the amount of the second mortgage does not exceed the value of the home.
Banks are sometimes reluctant to lend second mortgages to individuals with risky credit, because in the event of default, the second mortgage is subordinate to the first. The law would require you to pay off your first mortgage before your second. Thus, interest rates tend to be higher on a second mortgage.
Generally, banks will only lend you an amount equivalent to your level of home equity. If your home is worth $200,000 and you still owe $120,000 on your first mortgage, many lenders will only allow you to take out an $80,000 second mortgage. You may be able to obtain a second mortgage that exceeds your equity, or even one that exceeds the value of your home, with an excellent credit rating and at a correspondingly higher mortgage rate. However, the IRS only allows the interest you pay on your second mortgage to be tax-deductible to the extent that it corresponds to your home’s value.
During the process of mortgage application and qualifying for a second home loan, you will have to decide whether a home equity loan (HEL) which is a lump sum amount, or a home equity line of credit (HELOC) which works more like a credit card, is more appropriate to your financial situation. As with any large loan, do not borrow more than you are prepared to pay back.