The average U.S. homeowner possessed an impressive $288,000 in equity at the midpoint of 2023, according to CoreLogic. This was a substantial increase from the $182,000 recorded prior to the COVID-19 pandemic. One popular way to access home equity is with a second mortgage.

“Non-QM second-lien mortgages also offer greater creativity in underwriting, making it possible for borrowers with less-than-perfect credit histories or irregular income streams to access equity.”

A second mortgage provides homeowners with a convenient and flexible source of funds. Whether the funds are used to finance home improvements, consolidate debt, subsidize education or secure additional investments, second mortgages are an effective means to achieve personal financial goals.

In 2022, this market expanded with the introduction of a nonqualified mortgage (non-QM) version of a second lien. Non-QM loans are those that cannot be purchased by the federal government or the government- sponsored enterprises, Fannie Mae and Freddie Mac. Conventional and non-QM second mortgages are tools for mortgage originators to help clients meet their financing needs.

Second lien

A second mortgage is a type of loan that is taken out on a property that already has a primary mortgage in place. It is also commonly referred to as a second lien because it is subordinate to the first mortgage. In case of default, the first mortgage lender has priority in recouping their money from the sale of the property.

Because of the existing first mortgage on a property, a second mortgage is taken out against the portion of the home that has already been paid off. A lender will determine how much equity is in the home and will then structure a loan against a portion of it, leaving the first mortgage fully intact.

Second mortgages are popular with borrowers for many reasons. First, unlike other types of loans, the money from a second mortgage can be used for almost any purpose. Second, interest rates on second mortgages are substantially lower than other kinds of consumer debt products. This is why it’s especially appealing to use funds from a second mortgage to pay off high-interest credit cards.

Finally, when a borrower takes out a second mortgage on their home, they can receive the entire amount of the loan in a lump sum at closing. Depending on their circumstances and how they intend to use the funds, this can be particularly advantageous to the borrower.

Informed decisions

Understanding the intricacies of second mortgages is crucial, as it can empower homeowners to make informed decisions and maximize their equity without compromising their long-term financial security. Like any major financial decision, there are pros and cons to consider when borrowing funds in this fashion.

Second mortgages often come with lower interest rates compared to credit cards or personal loans because they are secured by a home’s equity. If the second mortgage funds are used to erase high- interest debt, this can result in significant savings to the borrower.

The interest paid on a second mortgage is deductible, albeit only under certain terms. The type of loan and the amount of debt, as well as the loan origination date, are factors that can determine whether a second mortgage qualifies for a tax deduction. Investing the funds from a second mortgage into home improvements can increase the value of a property, potentially providing a return on investment when the house is sold.

But there are drawbacks. Since a second mortgage is secured by a borrower’s home, failure to make payments could lead to foreclosure. Acquiring a second mortgage means the assumption of more debt. It is crucial for borrowers to ensure they can afford the additional payment without straining their budget.

Obtaining a second mortgage may involve the payment of various expenses, including application fees, appraisal costs and closing costs. These additional fees can increase the overall cost of the loan. A second mortgage also reduces the equity in a home. Economic changes or a decline in the housing market can affect the value of a home, potentially leaving a borrower with less equity than they might have expected.

Another option

For some borrowers who wish to access the equity in their homes, a home equity line of credit (HELOC) might be a more suitable option than a second mortgage. Both types of loans allow homeowners to access money from accrued equity.

A HELOC, however, is substantially different in terms of how funds are accessed, the repayment obligations and other key aspects. A borrower’s home serves as collateral for the loan.

The lender will typically determine the maximum amount that can be borrowed based on a percentage of the home’s appraised value and the remaining first mortgage balance.

The lender will establish a set credit limit, and the borrower can access and repay money as needed within that limit. HELOCs usually have a draw period of five to 10 years. During this time, the borrower is only required to make interest payments on the amount that has been withdrawn.

After the draw period ends, the borrower enters the repayment period. During this phase, no more money can be taken out, and the borrower begins to repay the loan principal and interest. Repayment periods typically last 10 to 20 years. HELOCs are generally offered with variable interest rates, which means that the rate can change over time based on fluctuations in a specified benchmark, such as the prime rate.

Individual situations

Whether a second mortgage or a HELOC is a better option for a homeowner depends on individual financial situations, goals and preferences. There’s no one-size-fits-all answer, as both options have their own advantages and disadvantages.

Second mortgages often come with fixed interest rates, which means that the borrower’s monthly payments remain consistent over time. This can provide more stability and predictability compared to HELOCs, which usually have variable rates.

If your client needs a significant amount of money upfront for a specific purpose, a second mortgage might be more suitable as it typically provides a lump sum. Since second mortgages come with a fixed repayment schedule, it can be easier to budget for these regular payments over the life of the loan. This can be especially beneficial for homeowners who prefer the discipline of consistent payments.

If current interest rates are favorable, a second mortgage with a fixed interest rate can help you lock in the same rate for the entire loan term, protecting the borrower from any future rate hikes. Second mortgages often have longer repayment terms compared to HELOCs. This can result in lower monthly payments, which might be advantageous for homeowners with tighter budgets.

When a borrower takes out a second mortgage, they make a one-time decision regarding the loan amount and terms. This can be appealing if they prefer to secure a specific amount of money without ongoing access to credit like a HELOC.

Greater flexibilty

The introduction of non-QM second mortgages are blazing a new trail for even greater flexibility to tap into home equity. Non-QM second-lien mortgages stand out in the world of lending due to their unique characteristics and flexibility.

Unlike traditional mortgages, these loans do not conform to the stringent guidelines set by Fannie Mae and Freddie Mac. This nonconformity allows lenders to tailor loan terms to individual borrowers, making them an attractive option for those with unique financial situations or nontraditional income sources.

Non-QM second-lien mortgages also offer greater creativity in underwriting, making it possible for borrowers with less-than-perfect credit histories or irregular income streams to access equity. While they may come with slightly higher interest rates to mitigate risk, these loans provide an invaluable alternative for those who wouldn’t otherwise qualify for traditional financing, highlighting their distinctive place within the mortgage market.

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Whether it’s a second mortgage or a home equity line of credit, these loans provide homeowners with access to additional funds, allowing them to finance major expenses or pursue financial goals. Before they choose to go this route, it’s essential to carefully assess your client’s financial situation, compare interest rates and terms from different lenders, and consider the potential risks and benefits. ●

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First American Financial Corp. reported that U.S. home prices peaked for a seventh straight month in October 2023. Annualized price growth at that time increased to 7% after bottoming out in the first half of the year. Meanwhile, Attom reported that nearly half of residential properties with mortgages in third-quarter 2023 were considered “equity rich,” meaning the amount of debt secured by these homes didn’t exceed 50% of their estimated market values.

At a time when home purchase business remains tepid, originators who once overlooked home equity lending products might want to reconsider them. Many lenders have already jumped on the bandwagon: According to data from the Mortgage Bankers Association (MBA), home equity loan and home equity line of credit (HELOC) originations jumped by 50% from 2020 to 2022.

“We see a lot of potential in this space, especially if there are more outlets in the secondary market.”

Marina Walsh, vice president of industry analysis, Mortgage Bankers Association

Across the 20 companies that participated in the MBA’s study, the average origination volume of these loans grew by nearly $1.2 billion during the two-year period. At the end of 2022, homeowners had roughly $31 trillion in total equity, triple the levels seen in the years immediately following the Great Recession.

“We see a lot of potential in this space, especially if there are more outlets in the secondary market,” says Marina Walsh, the MBA’s vice president of industry analysis. Walsh notes that banks are concerned about any loans they’ll hold on their books — particularly after the recent failures of a few institutions — but she also says that alternative lenders are emerging in the home equity channel.

These lenders tend to be fintechs that offer speed and convenience for online applicants, making their home equity loans more competitive against personal loans and credit cards. But they’re also excelling at strong underwriting standards and borrower analytics, Walsh says.

“Unsecured lending is just an easier process for borrowers,” she says. “Some borrowers are still remembering the overleveraging from the Great Recession. A lot of education is needed to show that (an equity-based loan) makes financial sense.”

There are several reasons why these products haven’t been more popular in previous market cycles, says Anthony Stratis, senior director of lending partnerships at Figure, a nonbank HELOC lender. These include a lack of compensation for the mortgage company and originator, few options for selling the loans on the secondary market and long funding times (MBA data pegged the average closing period for a HELOC in 2022 at 41 days).

Yet another potential hurdle, Walsh notes, is the personnel tasked with managing these types of financing requests. Consumer lending divisions, rather than mortgage divisions, were responsible for the bulk of home equity loan and HELOC originations among the lenders surveyed by the MBA.

“I hear more about trying to consolidate consumer products, technology-wise, into one loan origination system, so you have more of the prominent lenders providing a home equity loan add-on,” Walsh says.

Stratis believes that the overarching movement in consumer financial services toward online speed and convenience presents an opportunity to educate both consumers and originators. The modern home equity lending process is increasingly likely to resemble that of a personal loan.

“The credit unions and banks, I think they’re very good at being able to offer these products,” Stratis says. “But the process by which they do it is traditional in the sense that you’ve got manual underwrites that take place and a lot of paperwork going back and forth. … I think that’s a big barrier to a typical consumer, and not one that they necessarily want to go through for a $40,000 or $50,000 loan.” ●

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Per the December ICE Mortgage Monitor Report, mortgage holders across the country collectively hold $10.6 trillion in equity that could be accessed while still keeping a 20% equity stake in their homes. But only 0.41% of the tappable equity available at the start of the third quarter was withdrawn during this three-month period, representing less than half of the average withdrawal rate from 2010 to 2021. 

Consider that, throughout those years (which encompassed a variety of rate and market conditions, ICE noted), Americans with mortgages consistently withdrew slightly less than 1% of available tappable equity each quarter. 

“Despite the resurgence in tappable equity among U.S. mortgage holders, elevated interest rates are making homeowners reluctant to extract that wealth,” said Andy Walden, vice president of enterprise research for ICE. The untapped equity, Walden said, is “equivalent to $54 billion to $250 billion over the last 18 months in ‘missing’ withdrawals that might have otherwise stimulated the broader economy.” 

On the other hand, the growth in equity levels are playing a part in holding down default and foreclosure activity. Foreclosure starts grew to an 18-month peak in October, but they remain 35% below pre-pandemic levels.  

“Lenders and servicers have many more options for working with borrowers to avoid foreclosure today than at almost any point in the past,” Walden said. “Just to illustrate the scope: 70% of loans currently three or more payments past due are protected from foreclosure by ongoing loss-mitigation efforts. Further, 58% of these seriously delinquent mortgage holders hold more than 20% equity stakes in their homes.” 

Borrowers with large equity cushions have more incentive to work with servicers to keep their loan accounts in good standing, Walden said. They also have more options for avoiding distress, such as saving the equity they’ve earned through a traditional home sale rather than going through foreclosure. 

“The more the industry can do to educate and update borrowers as to their equity positions, the better,” he said. “Loss mitigation can be much more successful when a borrower can make educated and informed decisions, fully aware of the options available to them.” 

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In 2006, the median age of a home was 31 years, according to numbers compiled by the National Association of Home Builders (NAHB). The age of existing homes shot up rapidly after the Great Recession.

“Contractors have a tendency of flip-flopping between remodeling and new construction based on what earns them the most money.”

– Todd Tomalak, principal of building products, Zonda

“The housing stock is getting older and the reason is not mysterious,” says Paul Emrath, NAHB’s vice president for survey and housing policy. “We’ve just been building new housing at below-normal rates pretty consistently since about 2008.”

From the 1960s through the 1990s, builders produced about 1.5 million housing units per year. Since the Great Recession, however, they’ve produced far fewer, Emrath says. While home construction activity has risen in recent years, it’s only resulting in about 1.4 million new homes annually, about 100,000 shy of the historic norm. Homebuilders should be churning out even more homes to overcome the existing shortfall and account for population growth, Emrath says.

With fewer new homes coming onto the market, that’s pushed the typical age of an existing home dramatically higher. So, it’s no surprise that the U.S. is in the midst of a remodeling boom. Zonda’s Todd Tomalak says that the years between 2020 and 2030 may well be remembered as “the golden age of remodeling.”

“It’s a number of things that are all coming together at the same time in a way we haven’t seen in the data before,” says Tomalak, the company’s principal of building products.

In addition to aging homes, he also cited other reasons for the remodeling boom. For one, homeowners are sitting on record levels of equity. There’s also the lock-in effect, making owners with low interest rates unwilling to move. Some people purchased rashly during the COVID-19 pandemic and are stuck in homes they dislike. And in the past decade, major remodeling projects per household — as opposed to total dollar volume — were below the levels of previous decades.

Last year, mortgage lenders authorized $275 billion in home equity lines of credit (HELOCs) to U.S. homeowners. That’s the highest total since 2007, says CoreLogic chief economist Selma Hepp. The total amount authorized this year is estimated to decline to $178 billion as higher interest rates deter potential borrowers. Still, homeowners are expected to spend $486 billion on home renovations and repairs this year, the largest amount on record.

“Over the last few years, we’ve seen huge amounts of money spent on improvements and repairs,” Hepp says. “We do believe that number is sort of peaking and will decline slightly from that peak over the next year. Even with that decline, we’re looking at some of the highest levels that we’ve seen since the 1990s.”

Emrath agrees that the number of remodeling projects should decline soon. “It’s been so strong, that was a trend that couldn’t keep going forever,” he says.

Tomalak also believes there will be a lull, noting that homeowners have burned through money saved during the pandemic, credit card balances are rising and higher interest rates are cooling demand for HELOCs. But he thinks that remodeling will pick up after a brief pause and remain elevated through the rest of this decade.

If a homeowner dislikes their property, they can either move or remodel. In the 1990s, homeowners were 4.3 times more likely to move than to remodel, according to census data. By 2021, however, the average homeowner was 1.3 times more likely to move than remodel — a nearly equal likelihood to stay put rather than sell.

Tomalak likens it to holding a beach ball underwater. Without new homes to move into, owners will continue renovating. So, when will it pick up after the lull? “You tell me when rates begin to come back down,” Tomalak says. “If we kind of take what’s in front of us at face value, we would say that we’d begin to see strong growth again in Q4 2024.”

With so much money, labor and materials being spent on home renovations, is this taking away from new construction activity? Tomalak, Emrath and Hepp all say yes to some degree. Hepp cautions that remodeling and new construction activities vary by location.

“New construction is very much concentrated in certain parts of the country such as the Southeast, whereas a lot of renovations and repairs are happening in the parts of the country that are less affordable, where people are sort of sitting in their homes,” she says

Labor is one the biggest issues facing the home construction industry. Tomalak says there are only so many skilled contractors to hire. “Contractors have a tendency of flip-flopping between remodeling and new construction based on what earns them the most money,” he says.

There are lot more remodeling projects than new homes being built, Emrath says. “The typical remodeling project does not use as much labor and materials as new construction,” he notes. “But there are some 10 to 11 million remodeling projects a year compared to 1.5 million new homes being built. Even though there’s fewer laborers, there are more projects.” ●

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Keynova Group has been doing a survey on mortgages and home equity since 2005. Initially, the company focused on banks but expanded to nonbanks about five years ago after Rocket Mortgage, then Quicken Loans, began offering the first end-to-end online mortgage.

“We’ll see a continuing build-out of educational resources like articles and calculators.”

“Our bank customers were really curious about what they were doing,” said Beth Robertson, Keynova’s managing director. “So, we decided to add several of the large nonbank firms to the benchmark.”

In the 2023 survey, Keynova evaluated 350 criteria, from the mortgage application process to customer support features. Surveyed institutions included Bank of America, Chase, Citi, Citizens, PNC, Truist, U.S. Bank and Wells Fargo, as well as nonbank home lenders Freedom Mortgage, Guaranteed Rate, LoanDepot and Rocket Mortgage. Robertson spoke to Scotsman Guide about industry trends uncovered this year and how financial institutions could use this information.

Nonbanks are increasingly looking at home equity lending to replace refinance and purchase originations, right?

Since last year, Guaranteed Rate, LoanDepot and Rocket have all introduced or ramped up their capabilities relative to home equity. You can see that with Guaranteed Rate and LoanDepot. Rocket, at least at the time of our review, still was doing a lot in terms of educational content.

More lenders are also offering Spanish-language mortgage applications. Is that new?

That is something, again, that we’re seeing mostly from the nonbanks. Again, the same ones that I mentioned, Guaranteed Rate, LoanDepot and Rocket Mortgage. It’s something that’s good to see. It’s definitely going to make mortgages much more accessible to Spanish-speaking individuals.

Do you think that companies are just now realizing the size of that particular market?

Many of the firms — not just mortgage lenders but other digital firms — were talking a couple of years ago about browsers having the ability to translate from English to Spanish. They didn’t see the need, necessarily, for adding Spanish-language content.

That’s really changed as the (Hispanic and Latino) population has expanded significantly. When you get to something like a mortgage application, the information that is gathered is very important and it’s highly confidential. It’s important that it be translated correctly.

Why did more lenders offer digital goal-setting and planning tools?

Banks and nonbanks are trying to act as more of a partner with the individual and help them plan for all of their financial servicing needs. All of that has resulted in us seeing more of these goal-setting tools.

Did anything in this year’s survey surprise you?

There is starting to be more use of soft credit pulls. I think we’ll continue to see that early in the mortgage processes. You may see a soft credit pull, rather than anything that affects the borrower’s credit score, until they’re ready to go with something that’s more formal.

Do companies, both the ones surveyed as well as others, adjust their strategies based on the survey findings?

It’s important to see what others are doing. It doesn’t necessarily mean that you’re going to adjust your own strategy. You can look at what others are doing and maybe use it to justify internally your own initiatives, or to help you plan new initiatives.

Any expectations for what you’ll find in the future?

That’s somewhat harder to say, but I do think we’re going to see a lot more Spanish capabilities in terms of the lending content and educational resources. We’ll also see more Spanish language in customer support tools like virtual assistance, as well as dedicated Spanish dial-in lines.

We’ll also see some more rollout of soft credit pulls, because that encourages somebody to find out if they’re eligible without affecting their credit rating. We’ll see a continuing build-out of educational resources like articles and calculators, and other sorts of tools that can be integrated more broadly across a digital property.

Do you think that nonbanks looking at home equity lending is a blip on the map?

Once they’ve gone through the product rollout and the support that they need for home equity, the nonbanks will likely stay there. Then they can offer a wider array of products to meet customer needs depending on the current market situation. ●

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A new report from CoreLogic revealed that U.S. homeowners with mortgages saw their equity fall by 1.7% year over year in Q2 2023, a collective loss of $287.6 billion and an average loss of $8,300 per borrower. On a quarterly basis, however, homeowners with mortgages realized a 5.2% gain on their equity, a collective bump of $806 billion for an average of $13,900 per borrower.

The average American homeowner now has roughly $290,000 in home equity.

“While U.S. home equity is now lower than its peak in the second quarter of 2022, owners are in a better position than they were six months ago, when prices bottomed out,” said Selma Hepp, chief economist for CoreLogic. “The 5% overall increase in home prices since February means that the average U.S. homeowner has gained almost $14,000 compared with the previous quarter, a significant improvement for borrowers who bought when prices peaked in the spring of 2022.”

Mortgage-holding homeowners in the West saw the largest year-over-year declines in equity by region from April through June, driving much of the annualized plunge nationwide. In Washington state, homeowners with mortgages had the largest equity loss by dollar amount at an average of $54,000 per borrower, followed by those in California at $48,000.  Homeowners in Nevada and Utah had the third-largest decreases at $41,000 each.

Notably, despite the big equity losses, homeowners in many western states still have the most accumulated equity overall, due to the rapid pace of home price appreciation (especially in pricey coastal areas) over the past 10 years.

Only 2% of homeowners carrying mortgages were underwater on their loans as of the second quarter. That’s about the same share as was recorded over the past two years and a far cry from the peak of 26% logged in 2009 in the wake of the Great Recession.

Also notable is the geographical disconnect between price declines and negative equity concentrations, Hepp said.

“While more borrowers are underwater compared with one year ago, they are not necessarily concentrated in markets that have seen the largest price declines, as negative equity also depends on the downpayment,” she said. “Natural disasters and related risks also play a substantial role in home equity changes.”

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With median home prices dropping by 2.6% from June to September, equating to a typical decline of $11,560, Black Knight’s newest Mortgage Monitor report revealed that the decline in equity during third-quarter 2022 represented by far the largest three-month slide in dollar volume on record. With 7.6% of nationwide equity vanishing during the same period, it also represented the largest decrease on a percentage basis since 2009.

Equity among mortgaged homes is now almost $1.5 trillion (8.4%) off its peak, which was reached in May 2022. The average borrower’s equity is down $30,000 since then.

“While hitting a record high in Q2, total homeowner equity peaked mid-quarter in May and has been pulling back ever since,” said Ben Graboske, Black Knight’s president of data and analytics. “From a risk perspective, we’ve already seen the number of underwater borrowers more than double alongside the equity pullback.” 

Meanwhile, tappable equity — the amount available to homeowners to borrow against while still maintaining 20% equity in the home — has plunged. Black Knight’s prediction earlier in the fall that “a sizable reduction” of the metric was in the cards has been realized. Indeed, tappable equity at the end of September was at $10.5 trillion, down 9% from the second quarter and 10% below its May 2022 peak.

Graboske was quick to note that, despite the steep drops in equity and home values of late, home prices remain up 45% from the start of the COVID-19 pandemic. Median home prices are still at least 19% above their February 2020 levels in every major market in the country. And with home prices still elevated, the number of underwater homeowners remains far below previous norms, even with the recent bump.

“It’s important to note that – even with 275,000 falling underwater since May – fewer than half a million homeowners owe more on their homes than as currently valued. Historically speaking, that is still extremely low,” Graboske said.

“Also, as we’ve covered in prior Mortgage Monitors, the vast majority of homes at risk of falling underwater are those that were purchased in 2022 and late 2021, at or near pandemic-era peak prices,” he added. “This is obviously a situation that demands careful, ongoing monitoring, but to put that into context, just 3.6% of nearly 53 million U.S. mortgage holders are either underwater or have less than 10% equity in their homes – roughly half the share coming into the pandemic.

While additional declines may be on the horizon, Graboske noted, homeowner positions remain broadly strong. Mortgage holder equity is still $5 trillion (46%) above pre-pandemic levels, equating to an average gain of more than $92,000 per borrower in that time span. Along with rising interest rates, declining levels of equity increase the potential for further headwinds in home equity lending and heighten default risk, he said.

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