How to Use a Second Mortgage to Buy a Home
- What is a Second Mortgage?
- Second Mortgages Prior to the Real Estate Crisis
- How to Use a Second Mortgage to Purchase a Home
- Afford more home. When combined with a first mortgage, a second mortgage may enable you to purchase a higher priced home. For example, your first mortgage lender may only qualify you for a certain loan amount based on your monthly gross income and debt. A second mortgage lender may apply more flexible qualification requirements and approve you for an additional loan. For example, if you have $20,000 saved for a down payment and are approved for a $80,000 mortgage, you could buy a $100,000 home. If you are also approved for a $15,000 second mortgage you could potentially buy a $115,000 home so the second loan increases your buying power.
- Reduce your down payment. You can use a second mortgage to lower the down payment you need to make to purchase a home. For example, if you are required to make a down payment of $20,000, a $10,000 second mortgage cuts your required financial contribution in half. Saving for a down payment can be challenging for many home buyers so using a second loan may enable you to buy a home quicker.
- Avoid paying private mortgage insurance (PMI). If a borrower does not have sufficient funds to make a 20% down payment he or she may use a second mortgage so that the loan-to-value (LTV) ratio on the first mortgage does not exceed 80%. Borrowers typically are required to pay private mortgage insurance (PMI) if their down payment is less than 20% (LTV ratio exceeds 80%) so obtaining a piggyback mortgage enables the borrower to avoid paying PMI, which is an additional ongoing cost on top of your monthly mortgage payment. In this scenario borrowers should compare the extra cost of the second loan to the cost of paying PMI to determine the right financing option.
- Lower the interest rate on your first mortgage. Borrowers may also decide to use a second mortgage to buy a home if their first mortgage exceeds the conforming mortgage limit in their county, which means their loan is categorized as a jumbo mortgage. In some cases, the mortgage rate for a jumbo loan is higher than the rate for a conforming mortgage so obtaining the second mortgage and pushing the first mortgage below the conforming loan limit enables the borrower to pay a lower mortgage rate. Paying a lower interest rate on your first mortgage can save you a lot of money in the long run.
- Qualify for Certain Mortgage Programs. Most low down payment mortgage programs apply loan limits which cap the amount of your first mortgage. You can use a second mortgage to reduce your first mortgage so that your loan amount is below the applicable loan limit for a loan program. For example, if the FHA loan limit is $294,515 and you want to buy a home for $350,000, you could use an FHA loan for $294,515 and then a second mortgage for part of the remainder of the purchase price. In this case, using the piggyback loan enables you to qualify for the program.
- Second Mortgage Qualification Requirements
- Piggyback Loan Rates and Fees
- Second Mortgage Lenders
- Second Mortgage on a Home with an Existing Mortgage
A second mortgage, also known as a second trust deed or a piggyback mortgage, is a second loan on a property that uses the equity in the property as collateral for the loan. The second mortgage is subordinate, or junior, to the first mortgage on the property which means that in the event of a default or foreclosure, the holder of the first mortgage is paid off first before the holder of the second mortgage. For mortgages, priority is determined by the order in which the lien is recorded. So a first mortgage is recorded before a second mortgage so the holder of the first mortgage has first priority while the holder of the second mortgage is second in line.
For example, if you want to buy a home for $100,000, you could use a $80,000 first mortgage plus a $10,000 second mortgage and a $10,000 down payment to complete the purchase. In this case, the second mortgage reduces the down payment required by the buyer but you can also use a second mortgage to buy a higher priced home or for several other reasons as we discuss below.
Second mortgages to purchase a home usually have a fixed interest rate and monthly payment, which makes them very similar to a home equity loan you obtain if you already own your home and have an existing first mortgage in place. The term of the second mortgage is usually 10, 15 or 20 years so you pay it off sooner than a 30 year mortgage.
In less common cases, a second loan may be structured as a line of credit. A home equity line of credit enables you to draw down, or borrower from, the line of credit as needed, and then repay the line as many times as you want. For example, you could obtain a $20,000 line of credit, only draw down $10,000 initially to buy a home and then borrower more money from the line in the future.
Borrowers used to be able to easily obtain second mortgages from banks to pay for part or all of the down payment required to buy a property. These were referred to as 80/20 or 80/10/10 mortgages or piggyback loans because you would use a first mortgage for 80% of the property price and then add second mortgage to finance an additional 10% or even 20% of the purchase. In many cases borrowers could use a second mortgage to buy a home with no down payment, which probably enabled them to purchase homes they could not afford.
Buying a home with no down payment also leaves you with no equity in your home and if your property value decreases, you are underwater on your mortgage. Many people who used a second mortgage or piggyback loan to buy homes lost their property to foreclosure when property values declined during the real estate market collapse.
This is why after the real estate market collapse in 2008, second mortgages to purchase homes became more difficult to find. Over the past several years, however, more lenders have started to offer piggyback mortgages again including many large, national lenders. This time, stricter loan qualification requirements afford more protection to both borrowers and lenders. For example, most lenders do not allow you to use a second mortgage to buy a home with no down payment.
Although qualification guidelines have changed, there are multiple reasons to use a second mortgage to buy a home. Below we outline the potential benefits of using a piggyback loan:
The qualification requirements for second mortgage are similar to the requirements for a first mortgage and focus on your combined loan-to-value (CLTV) ratio and debt-to-income ratio.
CLTV ratio is your first mortgage amount plus the second loan amount divided by the property value, as determined by an appraisal report. For example, if a property appraises for $100,000, your first mortgage is $80,000 and your second mortgage is $10,000, the combined loan-to-value ratio is 90%. $80,000 + $10,000 = $90,000 (total loans) / $100,000 (property value) = 90% CLTV.
For a second mortgage to buy a home, lenders typically permit a maximum CLTV ratio of 90% although some lenders may only permit a maximum CLTV ratio of 85%, which means the borrower is required to contribute a down payment of 10% to 15% of the property purchase price. So gone are the days of being able to qualify for a piggyback loan with a CLTV ratio of 100%, but a second mortgage can still be helpful to homebuyers.
A homebuyer may also be able to arrange a second mortgage directly with the a property’s seller, which is called seller financing or the seller taking back a note, but this is relatively unusual.
In addition to CLTV ratio, second mortgage lenders also focus on the borrower’s debt-to-income ratio which is how much of your monthly gross income you can spend on your monthly mortgage payments, property tax and homeowners insurance as well as other debt expenses such as credit card, car and student loans. First mortgage lenders typically apply a maximum debt-to-income ratio of 43% to 50% while second mortgage lenders permit higher ratios of 55% and above in some cases. Using a higher debt-to-income ratio enables you to qualify for the piggyback loan but make sure you can afford the addition monthly payment.
The interest rate on a second mortgage is typically 1.0% to 2.5% higher than the interest rate for a first mortgage, depending on the CLTV ratio -- the lower the CLTV ratio, the lower the interest rate. Borrower should always compare their combined monthly payment for a first and second mortgage to the single monthly payment for a first mortgage to understand the approach that makes the most financial sense for them. You are also required to pay a separate fees for a second mortgage which increases your total closing costs.
Second mortgages are offered by traditional lenders such as banks, mortgage banks and credit unions. Ideally, you would obtain the piggyback loan from the same lender that is providing your first mortgage but that is not always possible. Although more lenders are offering second mortgages, you may need to shop around to find one.
Click on lenders below or MORTGAGE RATES to find lenders that offer second mortgages
It is much more common to get a second mortgage on a home that you already own that has an existing mortgage. The most common types of second mortgage in this case are a home equity loan or line of credit (HELOC). The home equity loan or line of credit enables the borrower to access existing equity in the property without having to refinance the first mortgage. We explain how a home equity loan works and how a HELOC works for you to review.