How Does a Second Mortgage Work?

© 2009, Brandon Cornett. All rights reserved.

Question: “We have been told that we may want to consider a second mortgage loan when buying our home, in order to avoid extra insurance fees. How does a second mortgage work, and why do people use them?”

If you were told this by a lender, I would ask them to explain it. I’m happy to provide some basic information, but the lender can give you more specifics. Basically, a second mortgage works just like the first one, but is generally for a smaller amount. They are also sometimes referred to as piggyback mortgages, since the second loan is stacked on top of the first.

There are two primary purposes for these loans:

• Some people use second mortgages to purchase a home. If they cannot qualify for the amount they want with a single mortgage, they will apply for a second on top of the first. For example, they might use an 80-15-5 strategy to buy the home. They would get a primary mortgage loan to cover 80% of the purchase price, a second mortgage for 15% of the price, and they would put 5% down.
• You can also use a second mortgage to pull cash out of your home’s equity. In this scenario, the second functions as a home equity loan. We did this a few years ago to pay for a swimming pool. We took out a second to cover the cost, and we drew on our equity in the process.

When you use the first strategy explained above, you can also avoid paying private mortgage insurance, or PMI. If a lender gives you more than 80% of the purchase price (i.e., you put less than 20% down), you’ll have to pay for PMI coverage. This type of insurance protects the lender against a possible default down the road.

The second “piggyback” mortgage will generally carry a higher interest rate than the primary loan. But if you have good credit and get a decent rate on the primary, you could still end up paying less with two mortgages than if you got one mortgage for 80% and paid PMI on it.

I hope this helps you understand how second mortgages work, and I wish you well in your home buying process. If you have any other questions about this subject, feel free to use the Q&A service again.