First and Second Mortgage Loans: Understanding Your Home Financing Options

Most people use a mortgage loan to finance the purchase of a home. A mortgage is a loan that uses the home as collateral – if you don’t make your payments, the lender can foreclose on the home.

Types of Mortgage Loans

There are two main types of mortgage loans:

First Mortgage Loans

A first mortgage loan is the primary loan used to purchase a home. It has the first claim on the home if you default. First mortgages make up the bulk of the financing for most home purchases.

Some common types of first mortgage loans:

• Conventional loans – Loans not backed by the government. Typically, it requires a down payment of at least 10-20%.
• FHA loans – Insured by the Federal Housing Administration. Require a lower down payment of 3.5%.
• VA loans – For veterans and active duty military. Require no down payment.
• USDA loans – For homes in rural areas. Also, it requires no down payment.

First mortgages typically have 15 or 30-year repayment terms with a fixed or adjustable interest rate. The longer the term, the lower the monthly payment, but the more interest you pay over the life of the loan.

Second Mortgage Loans

A second mortgage is a subordinate loan that is second in line behind the first mortgage. It uses your available home equity as collateral.

Second mortgages are helpful for:

• Covering a down payment if you can’t afford 20% for a first mortgage
• Paying for home renovations or repairs
• Consolidating higher-interest debt
• Accessing your home equity for other major expenses

Some common types of second mortgage loans include:

• Home equity loans – Lump sum loans with fixed monthly payments and 5-30-year terms.
• Home equity lines of credit (HELOCs) – Revolving lines of credit you can draw from as needed. Typically, they have variable interest rates.

How First and Second Mortgages Work Together

Here is how first and second mortgage loans combine for home financing:

• You get an 80% first mortgage to purchase the home. This covers most of the purchase price.
• You also get a 10% second mortgage to cover the down payment. This avoids paying PMI (private mortgage insurance), which is required for low down payment first mortgages.
• Together, the two mortgages equal 90% financing with no PMI. The second mortgage gives you the remaining 10% needed for the purchase price.

This approach minimises the out-of-pocket expenses needed to buy the home. It allows you to buy with less cash or savings.

The risk is that second mortgages often have higher interest rates than firsts. Paying off the second mortgage early can save substantial amounts of interest.

Should You Get a Second Mortgage?

Here are some pros and cons of using a second mortgage:

Pros:

• Allows lower down payments on first mortgages
• Can provide funding for renovations, repairs, or other needs
• It gives access to your home equity without selling

Cons:

• Higher interest rates than first mortgages
• Adds another monthly payment
• The second position means the second mortgage is at higher risk of default
• Can make it harder to qualify for future refinancing

Generally, a second mortgage makes the most sense if you need to minimise your down payment and qualify for a reasonable interest rate. Or if you need to tap your equity for a significant purchase like renovations.

Use caution if considering a second to have extra cash on hand – the higher interest costs may outweigh the benefits.

How to Qualify for First and Second Mortgage Loans

Getting approved for both a first and second mortgage requires meeting specific qualifications. Here are some tips for qualifying:

• Have good credit – Lenders will check your credit score and report. Shoot for a score of at least 700 to get the best rates. Pay down debts and correct any errors on your report.
• Lower your debt-to-income ratio – Lenders look at your monthly debt payments compared to income. Keep this below 40%. Pay down credit cards and other debts.
• Make a down payment – Put at least 10-20% down on the first mortgage and the remaining 3-10% on the second—lenders like seeing you invest cash upfront.
• Show stable income – Provide W-2s, pay stubs, and proof of assets to verify you have a steady income to repay the loans. Being self-employed makes qualification harder.
• Choose the right property – Opt for a home within your price range. Make sure it appraises for the purchase price and is eligible for financing.
• Check rates and fees – Compare options from multiple lenders. Look for competitive rates and low origination fees. Get quotes for both mortgages.
• Consider mortgage insurance – PMI may be required if your first mortgage down payment is less than 20%. Weigh the cost vs. using a second mortgage.

With careful planning and preparation, dual loan qualification is very feasible. Work on optimising all the above factors to improve your chances.

Final Thoughts

First and second mortgage loans are essential in financing a home purchase. Together, they provide a way to buy your desired home even if you still need to get a complete 20% down payment saved up.

Make sure to shop around and compare interest rates and fees for both types of loans. A mortgage broker with access to multiple lenders can help find the best combination of loans for your situation.

Understanding all your mortgage options will help you make an intelligent, informed home financing decision and get the keys to your new home much sooner!