Closed-end second mortgage: Defined
A closed-end second mortgage loan (or CES loan) is a second mortgage that allows you to tap into your home equity without affecting the rate on your first mortgage.
Some types of second mortgages can be “open-end,” which means you can continue to take cash out up to the maximum limit and then draw again as you pay down the loan (not dissimilar from a line of credit).
But a “closed-end” second mortgage means you’ll receive the entire loan amount in one lump sum and won’t be able to withdraw any more cash after you receive the loan.
How does a closed-end second mortgage work?
A closed-end second mortgage (sometimes called a closed-end home equity loan) will allow you to receive up to 80% of your home’s equity in a lump sum payment, though this depends on your credit score, income, and other factors.
You’ll typically be locked into a set loan term (e.g., 20 years), with monthly payments required for the duration of the mortgage loan. This setup makes this type of loan ideal for those who intend to remain in their home for a long period of time.
A closed-end second mortgage also has some restrictions. For example, if you’re in the middle of paying off another loan that uses your home equity, you must seek the consent of your mortgage lender if you need additional financing.
Benefits of a closed-end second mortgage
A closed-end second mortgage is a great option for certain types of homeowners. Here are just some of the advantages of a closed-end second mortgage:
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Quick cash
This type of loan gives homeowners quick access to large, lump-sum cash payments. And there’s no restriction on how you use this cash — you can use it to pay off debts, finance further education, or make major home renovations without having to use options like a personal loan.
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An option for a fixed interest rate
If you take out a home equity line of credit (HELOC), you’ll most likely receive a variable interest rate. A closed-end second mortgage gives you the option of a fixed interest rate, which can be ideal if you lock in your rate when interest rates are low.
Disadvantages of a closed-end second mortgage
Of course, a second mortgage is always a major decision, and you’ll need to consider your options carefully. A closed-end second mortgage has some drawbacks, including:
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You risk losing your home
When using your home as collateral, you’ll have to ensure that you meet your required payments — otherwise, the lender can foreclose on your home.
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High closing costs
Obtaining a second mortgage means you’ll have to pay for an appraisal, miscellaneous fees, and other closing costs. These can quickly add up to anywhere from 2% to 5% of the loan amount.
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High interest rates
While it’s true that second mortgages offer fixed interest rates, they usually offer a higher interest rate than those found on a typical home equity line of credit (HELOC).
What is the difference between a refinance and a closed-end second mortgage?
There are many different forms of real estate financing available, including mortgage refinancing. But a second mortgage is very different from a mortgage refinance.
When you refinance your mortgage, you replace your existing mortgage with an entirely new one. This setup means that you’ll still have only one mortgage payment in the end.
You might consider a mortgage refinance to secure a lower interest rate, though a cash-out refinance allows you to convert your home’s existing equity into cash. If you do opt for a cash-out refi, then you’ll likely be paying a higher principal once the loan is made.
A second mortgage is exactly that: a second loan that exists on top of your existing loan. This setup means you’ll now be responsible for both loans, whereas a refinance deals only with one loan.
The advantage of a second mortgage is that, unlike a refinance, it doesn’t require you to change the interest rate on your first mortgage.
