A Guide for Borrowers to First and Second Mortgage Options
Buying a home is one of the biggest financial undertakings you can make during your life. Not many people can afford to buy their homes outright when the deal closes and need assistance in the form of a mortgage, or two. Here are the main types of mortgages borrowers can utilize when thinking about how to afford a home.
First mortgages are the simplest to understand. When someone wants to buy a house, the initial mortgage taken out to finance buying the property is considered the first mortgage. If someone has multiple homes, the initial loan on each property would be considered the first mortgage. These loans are considered the first lien meaning they are the primary loan to finance the property and priority to pay off should the borrowers default on payments and the house be foreclosed.
Many first mortgages are around 80 percent of the sale price of the home. The second mortgage is usually somewhere between 10 to 20 percent of the sale price of the home, which allows borrowers to purchase a home with very little or no down payment. However, a 20 percent second mortgage creating a no-money-down payment on a home purchase is much rarer in the post-2008 housing crisis era we currently live in.
Second mortgages come in a variety of options to choose from to cater to your financial needs. The differing features of these loans are based on when you close the second mortgage relative to the first mortgage, the type of interest rate you want, and how you want to receive the money.
When you are looking to buy your home and shopping for a first mortgage loan, you may also want to consider a piggyback second mortgage loan at the same time. This second mortgage is helpful if you want to avoid paying for private mortgage insurance on your first mortgage by limiting your first mortgage loan amount to 80% of the appraised value of the home you are purchasing. It can also be financially beneficial to limit your first mortgage loan amount to the conforming loan limits established by Fannie Mae and Freddie Mac, which can differ depending on the property location. Borrowers who have taken advantage of piggyback loans will generally have a first mortgage loan for 80% of the home’s appraised value, a 10% piggyback second mortgage loan, and thus requiring a 10% cash down payment.
A Standalone second mortgage can be made at any time after the first mortgage is closed. Many homeowners do this if their house value has appreciated over time and do not want to refinance their first mortgage loan but want to tap into their increased equity. There are two options then for people who want to do a standalone second mortgage. Either they can do a home equity loan or a home equity line of credit (HELOC).
For both of these options, the second mortgage is being financed by the equity in their home. The difference between these two lies in the interest rates and how money is dispersed. The home equity loan is traditionally a closed-end loan meaning interest is charged at a fixed interest rate with all of the loan proceeds disbursed upfront. A HELOC is a line of credit that gives borrowers greater flexibility. Borrowers can determine how much they want to borrow, when they want to borrow, with interest being charged at a variable interest rate. Ask your lender to confirm that there are no prepayment penalties associated with paying down the loan or line’s principal balance.
There are other key factors to keep in mind when taking out a second mortgage. The rates are usually higher than for the first mortgage as these loans are typically for smaller amounts and are riskier for the lender to make since they are subordinate to the first lienholder. In the event of a foreclosure, the first lienholder is paid off while the second lienholder has a higher risk of not recovering all of their principal and interest due from the remainder of proceeds in the foreclosure sale, hence the higher rates.
Now that you know about first mortgages and second mortgages (like piggyback loans and standalone seconds), you should be better equipped to decide which path is best for you and your family in the future. Contact one of our Loan Advisors to discuss in more detail the options available to you.