You might take out a second mortgage to tap your home’s equity, or it may be necessary to get a junior piggyback mortgage to avoid private mortgage insurance when you’re purchasing a home. But it’s important to understand the financial considerations involved before you take out a junior loan.
Definition and Examples of a Junior Mortgage
A junior mortgage is a second mortgage loan that you take out against your home’s equity using the property as collateral. A junior mortgage assumes that you already have a mortgage that’s also secured by the home. A junior mortgage forms a second lien against the property. They take a backseat to first mortgages for repayment purposes. The first mortgage lender would take priority when receiving any proceeds from the sale of the home if you’re unable to pay both loans and the home ends up in foreclosure. Junior mortgages would only be satisfied to the extent that there are any remaining profits to be had. These types of mortgages can carry higher interest rates than first mortgages because they’re generally riskier for the lender.
Alternate definition: A junior mortgage can refer to a second mortgage loan, but it can also be used to describe a third or fourth loan that’s secured using the home as collateral.Alternate name: Junior lien, second mortgage, piggyback mortgage
Home equity loans and HELOCs are common examples of junior mortgages. Both use the home as collateral, and both allow you to tap into the equity that’s accumulated in your home. Home equity loans are “closed end.” You’re borrowing a set amount of money. Home equity lines of credit are “open end” because you can draw against your credit line as needed.
How a Junior Mortgage Works
A junior mortgage can be used in one of two scenarios. One is to withdraw some of the equity in your home. This can involve taking out a home equity loan or a home equity line of credit. With a home equity loan, you borrow a lump sum of money based on the amount of equity in the home. The money can be used to consolidate debts, pay for home repairs, or another purpose. Home equity loans typically have a fixed interest rate and set repayment terms, so your monthly payment is predictable. The second mortgage lender could pursue a foreclosure action against you if you don’t pay back a home equity loan. A HELOC is an open-end credit line that you can draw against over time. This credit limit is based on the amount of equity you have in your home. You may be able to write checks or use a special credit card to withdraw money instead of taking a lump sum of money. HELOCs typically have variable interest rates so your monthly payments can change as the interest rate adjusts.
Ways You Might Use a Junior Mortgage
You might use a home equity loan or a HELOC to pay for a major kitchen renovation, cover outstanding medical bills, or consolidate high-interest debt. A junior mortgage could also save you money when purchasing a home if you’re able to qualify for a low rate and avoid paying private mortgage insurance (PMI) on your first mortgage. Private mortgage insurance is generally required for conventional mortgage loans when you’re putting down less than 20%. It’s referred to as a “piggyback mortgage” when you use a junior mortgage in this way. Say you want to buy a home but you can only put 10% down on a conventional loan. Ordinarily, you would finance 90% of the purchase and pay PMI on the loan. You’d still put 10% down if your lender offers a piggyback mortgage option, but you’d have two mortgage loans instead of one. The first would be for 80% of the purchase price, allowing you to sidestep PMI. You’d then have a second mortgage for 10% of the purchase price that piggybacks on the first. Piggyback mortgages aren’t as common as they were before the housing crisis of 2008. But you may be able to use a junior mortgage to avoid paying PMI if you’re able to find a lender that offers one.
Special Considerations for Junior Mortgages
The main disadvantage of a junior mortgage is that you’re creating additional debt. It could increase the risk of defaulting on one or both loans if you’re not able to make the monthly payments to either mortgage. You could lose the property along with all the money you’ve paid into both mortgages if the home ends up in foreclosure. Do some budget calculations in advance to ensure that having primary and junior mortgages at the same time is realistic and affordable. Consider how having multiple mortgage loans might impact your credit score and what could happen to your score if you default. Think about how much you’ll be able to borrow if you decide to take out a second mortgage. Lenders can limit the amount of equity you can withdraw when using a home equity line or HELOC. You can also be limited in how many junior mortgages you can hold at any given time.
