What is a second mortgage used for? Homeowners can take out a second mortgage on their property for a host of reasons. We’ve explained the basics of second mortgages and what a second mortgage is used for right here. You’ll be pleased to hear they can be used for many purchases and projects.
First, what is a second mortgage?
A second mortgage is a new mortgage taken out on a property in addition to the first mortgage, giving you a lump sum payment. The second mortgage borrows against home equity that the homeowner has accumulated by paying off some of their first mortgage, and/or through increasing property value.
For example, let’s imagine you bought a £250,000 property and still have £150,000 of the mortgage to pay off, leaving you with £100,000 home equity. You may be able to get a second mortgage secured against the home equity. We discuss how much you can borrow against your home equity later in this guide.
If the property was sold before both mortgages are fully repaid, the first mortgage would get priority to being paid off with the funds raised. Only after the first mortgage is fully repaid would the second mortgage provider be able to recover the money owed to them. Consequently, second mortgages typically have a higher interest rate than first mortgages.
Why would you take out a second mortgage?
Getting a second mortgage can be an advantageous way to access large amounts of credit that they may not be able to access through other credit options. For example, a second mortgage may be able to grant the homeowner a much greater loan than if they used an unsecured personal loan.
Homeowners typically use the money borrowed from a second mortgage to make big one-time purchases, such as vehicles, worldwide holidays, pay for private medical procedures and education. They’re even used to consolidate multiple debts.
But above all, the most common reason for using a second mortgage is to pay for home renovations.
How much can you borrow on a second mortgage?
The second mortgage borrows against the equity in your home, i.e. the value of your home minus the primary mortgage balance. A lender will allow homeowners that meet their eligibility criteria and affordability assessment to borrow against some but not all of their equity.
The more equity you borrow against creates a greater risk to the lender and the homeowner. The biggest risk is that the property value decreases and the homeowner ends up in negative equity. This is when you are paying more back on mortgages than the property is worth. It puts you at risk of exceptional debt if you cannot keep up repayments.
This is why most lenders will only let homeowners use a second mortgage to borrow against a maximum of 80% of their home equity amount. For example, if you have £100,000 home equity, you could borrow up to around £80,000.
What is a second mortgage used for?
As mentioned, the primary reason homeowners decide to take out a second mortgage on their property is to pay for home renovations. It’s common for people to start searching for a second mortgage for loft conversion projects or to pay for an extension. By renovating a home, it is possible that the property goes up in value and the homeowner’s home equity increases. Thus, by doing so it can decrease the risk of falling into negative equity.
Debt consolidation is another common reason to choose to get a second mortgage. They use the lump sum payment to pay off multiple other creditors with a higher interest rate than the second mortgage charges. Thus, they merge the debts into the mortgage and save some money in the process.
Some people want a second mortgage for property abroad. The homeowner uses the mortgage money to pay for a holiday home somewhere in sunny areas of Europe or further afield. The cost of property in some of these destinations is cheaper than in the UK, making it possible that the home equity can help them buy holiday homes outright.
How to get a second mortgage
Second mortgages are available with most mortgage lenders, such as online banks, high-street banks and building societies. You’ll need to apply for the most suitable and advantageous second mortgages with these lenders, and you may need professional mortgage advice to avoid potential pitfalls.
To be approved for a second mortgage you will need to have your finances assessed to ensure you can afford the projected repayments. This means giving details for income, existing debt (including a first mortgage) and allowing the lender to check your credit score.
What is the downside to a second mortgage?
Second mortgages can be a great option for some people, but they also come with some disadvantages. These mortgages tend to have a higher interest rate than initial mortgages and there may be various loan fees involved.
But the greatest downside of a second mortgage is that it will take you longer to own your home with no existing debt attached to the property. And if you don’t repay as agreed, there is a genuine risk of foreclosure and being made to sell the property to repay.
Second mortgages vs home equity loans
An alternative option to a second mortgage is to use a home equity loan or home equity line of credit (HELOC). These products also provide credit secured against the equity in your home. The difference between a HELOC and the others is that the money is not paid out as a lump sum. Instead, the homeowner accesses the full amount in instalments over time, called the draw period. And during this period, they only pay variable interest on the loan amount.
More second mortgage guidance with MoneyNerd!
For more information on second mortgages, second mortgage rates and where to find a second mortgage lender, stick with us at MoneyNerd. We just released a batch of new second mortgage guides with valuable information for homeowners requiring credit.