Each time you make a payment on your mortgage, you gain equity in your home. The difference between your property’s value and the amount you still owe on your mortgage is your home equity. You may be able to use this equity to borrow money, but is it better to get a second mortgage or refinance? How do you determine which is the best option for you? We compiled this guide to a second mortgage vs. refinance to define each option and help you compare their advantages and disadvantages.
Topics Covered
- What Is a Second Mortgage?
- When to Get a Second Mortgage
- What Is Refinancing?
- When You Should Refinance
- What Is the Difference Between a Second Mortgage and Refinance?
What Is a Second Mortgage?
When you obtain a second mortgage, you’re borrowing against the equity in your home. This cash is given to you in a lump sum or in installments via a credit line, depending on your preference.
Types of Second Mortgages
There are two kinds of second mortgages. These are known as a home equity line of credit (HELOC) and a home equity loan:
- Home equity line of credit: Another kind of second mortgage is a HELOC, which gives you continual access to your equity at a variable rate. When you take out a home equity line of credit, you’ll begin with a draw period. During this period, you typically can spend up to your credit limit and pay only your accumulated interest. After the draw period, you’ll pay back your remaining balance via monthly installments.
- Home equity loan: With this type of loan, you borrow against your home equity and receive a lump sum payment. You’ll pay back this loan in monthly installments at a fixed interest rate.
How Does a Second Mortgage Work?
Along with your monthly payment for your primary mortgage, you’ll make repayments on your second mortgage. If you obtain the primary mortgage and the second mortgage from different companies, you’ll pay each lender separately. As you make payments on both loans, you will regain equity in your home.
Keep in mind that you won’t be able to access all of your home equity when you choose a second mortgage. For instance, if you have $90,000 worth of equity, you may only be given access to $80,000. The amount of equity you may need to leave in your property can vary based on several factors, including your current debt, your credit score and your lender.
What Are the Requirements of a Second Mortgage?
One condition that comes with a second mortgage is that your mortgage lender will put a lien on your house when you’re given a loan or cash. Liens are legal claims to properties that allow a lender to seize the property under certain conditions. When you secure a second mortgage, you’ll have two liens — one with the lender of your primary mortgage and one with the lender of your second mortgage.
In this scenario, if you default on your home and the property goes into foreclosure, your primary lender will get their money first and the rest will go to your secondary lender. As a result, your secondary lender bears more risk and will likely offer you a higher interest rate.
Ensure you can comfortably make both payments each month. If you run into financial hardship, such as a job loss, you could be more likely to lose your house.
What Are the Advantages of a Second Mortgage?
When you take on a second mortgage, you may enjoy several advantages, including:
- Keeping current loan terms: If your primary mortgage has a great interest rate, you can keep this rate when you secure a second mortgage, as a second mortgage won’t replace your existing loan. Rather than change your current loan terms, a second mortgage will add an extra payment to your monthly expenses.
- Paying fewer closing costs: With a second mortgage, a home equity loan lender tends to cover most or all of your closing costs. Since you may not have to pay closing costs at all, you can save thousands of dollars.
- Deciding how you get the money: You can select whether you want a HELOC or a home equity loan. If you want a lump sum, you may want to select a home equity loan. If you want to tackle a home renovation or another ongoing project and you don’t know exactly how much money you may need, you may want to choose a HELOC instead.
What Are the Disadvantages of a Second Mortgage?
You may also deal with some drawbacks if you choose to take on a second mortgage, such as:
- Stuck with original mortgage terms: When you get a second mortgage, this won’t impact your original mortgage. With a second mortgage, you can’t change your primary mortgage’s interest rate or term.
- Additional monthly payment: On top of paying your primary mortgage each month, you’ll also have a monthly payment for your second mortgage. Missing a payment may risk the loss of your home.
- Another lien on your home: Having another lien on your home can put you at greater risk of foreclosure if you are unable to consistently pay your lenders.
When to Get a Second Mortgage
While a second mortgage isn’t right for everyone, it may be the right option for you. The following are some situations in which you may want to obtain a second mortgage:
- You want to keep your mortgage terms: Getting a second mortgage may be the right option for you if you want a lump sum of cash without changing your mortgage terms. While you may pay more interest on your second mortgage, you will keep your interest rate on the primary mortgage. This may not be an option if you choose to refinance instead.
- You don’t know how much money you’ll need: If you have an ongoing home project and you’re unsure how much money you will need upfront, a HELOC may be useful. With a home equity loan, you need to know how much you’ll need when you apply for this loan. When you secure a HELOC, you can make your payments as you go and use your line of credit up to the limit.
- You want to pay credit card debt: Compared to credit cards, second mortgages tend to have lower interest rates. If you have multiple credit card balances, you may want to take out a second mortgage to consolidate your credit card debt.
- You aren’t able to get a cash-out refinance: If you are rejected for a refinance, which tends to have a lower interest rate, you may be able to secure a second mortgage instead.
If you believe you can handle two monthly payments, a second mortgage may be the right option for you.
APPLY TODAYWhat Is Refinancing?
Refinancing is the process of replacing your primary mortgage with a new loan. When you refinance or remortgage, you can select a new lender, get a new interest rate, change your loan term or obtain a new loan type. With a refinance, you can:
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- Cover family expenses: Do you want to offer financial support to an older relative? Are you planning to start a family? Do you have a child heading to college soon? No matter what your goals are, having extra cash each month can help you adapt to major life changes.
- Make home improvements: If you want to invest in a new roof or an addition, refinancing can free up cash that you can use for renovations.
- Manage your cost of living: Your cost of living may have changed since you got your mortgage. You may have a new job or kids, and refinancing can make your mortgage more affordable so you can manage your new cost of living.
- Enjoy extra cash in your pocket: Whether you want to save, spend or invest, refinancing can help put extra cash in your pocket.
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The Types of Refinances
There are two types of refinances known as a cash-out refinance and a rate and term refinance:
- Cash-out refinance: A cash-out refinance lets you access your equity in exchange for a higher principal. For instance, if you have a mortgage with a $120,000 principal balance and you want to do $30,000 worth of repairs on your home, you would accept a loan of $150,000. You’ll then receive the $30,000 in cash after you close.
- Rate and term refinance: This type of refinancing lets you adjust how your mortgage is set up without impacting your principal balance. If you want to lower your monthly payment, you can accept a longer term. If you want to save on interest and own your house faster, you can shorten your loan term. You may also be able to refinance to a lower rate if market rates are now lower than when you obtained your mortgage.
How Does Refinancing Work?
The application for a refinance is similar to your original mortgage application. First, you’ll submit your financial documentation to the lender, and then the lender will underwrite your loan. In most cases, before you can refinance, you may also need an appraisal. With a refinance, you may need to pay for some of the same items as during your original mortgage process, including:
- Application fees
- An appraisal
- A home title search
After the underwriting and appraisal are completed, the next steps are closing and signing your new loan. If you obtain a cash-out refinance, you’ll likely receive your money a few days after you close on your loan.
As with a second mortgage, keep in mind that you may not be able to access all of your home equity when you choose a refinance.
What Are the Advantages of Refinancing?
Should you refinance your mortgage? When you take on a refinance, you may enjoy several advantages:
- You’ll pay only a single mortgage payment each month: You’ll replace your current mortgage with your new loan when you refinance, so you’ll only make one mortgage payment each month.
- You can change the term and rate of your loan: With a refinance, you may be able to adjust your term and rate, which can be useful if you are struggling to make your monthly mortgage payments. You may be able to replace an ARM with a fixed-rate mortgage or vice versa. If you secure a second mortgage, you may not have this option.
- You may be able to refinance all of your home equity: If you are eligible for a VA loan, you may be able to borrow all of your home’s equity.
- You may get a lower interest rate: You’ll face less risk when you have only one lien on your home. This means you may have a lower interest rate with a cash-out refinance than you would with a second mortgage. Market rates may also be lower now than when you secured your original loan.
What Are the Disadvantages of Refinancing?
If you choose to take on a refinance, you may also deal with some drawbacks, such as:
- You may be offered a different interest rate: You may be required to accept a different interest rate depending on the current market rates. If rates are higher now than when you secured your mortgage and you are forced to take on a higher rate, you may lose money.
- You may have to pay higher closing costs: When you refinance, you are responsible for paying your closing costs. This means you may need a few thousand dollars in cash when you close on your loan. You may be able to roll the closing costs into your loan, but this will increase your monthly payment.
When You Should Refinance
How do you know if refinancing is the right choice for you? There are many reasons you may choose to refinance, including:
- You want to change your term or rate: If you want to change the term or rate of your loan, you may want to choose a refinance. With a second mortgage, you cannot change your primary loan’s terms.
- You want to pay your mortgage faster: The sooner you can free yourself of a monthly mortgage payment, the more money you’ll be able to allocate to your other financial goals like retirement, vacations and renovations. If your mortgage is your only debt, paying it off will leave you debt-free.
- You want to eliminate private mortgage insurance (PMI): If you build up enough equity in your home you may be able to eliminate PMI.
- You want to take cash out of your equity: If you unlock the equity in your home, you can increase your cash flow and tackle those long-anticipated home renovations.
- You want to consolidate debt: If you have plenty of home equity and your aim is to consolidate debt, a cash-out refinance may be the right choice for you. When you reduce the number of bills you pay each month, you can simplify your finances.
- You want a lower monthly payment: With a lower monthly payment, you can keep more money in your pocket to save for other financial goals, such as your next family vacation or your kid’s college tuition.
Typically, you’ll have to cover closing costs, but compared to second mortgages, interest rates tend to be lower for cash-out refinances. To determine whether refinancing is right for you, try our refinancing calculator.
What Is the Difference Between a Second Mortgage and Refinance?
A home is a place to live, an asset and a potential source of cash to cover upgrades, repairs or emergencies. If you want to leverage your home’s equity to cover major costs, you may want to refinance your mortgage or secure a second mortgage. When you are considering a second mortgage vs. a cash-out refinance, weigh the pros and cons of both to determine which may be the right option for you.
Similarities Between Second Mortgages and Refinancing
With both a second mortgage and a cash-out refinance, you can use the cash as you choose. However, you may only want to borrow against the equity in your home if you want to consolidate debt or make home improvements. In each scenario, your house is considered the collateral. This means if you fail to make your payments, it may lead to foreclosure on your home.
Differences Between Second Mortgages and Refinancing
Second mortgages tend to have higher interest rates than cash-out refinances. However, closing costs are typically higher for a cash-out refinance than for a HELOC or home equity loan.
While a second mortgage is an additional loan to your first mortgage, a cash-out refinance is a single, larger loan. You will have another payment to make when you get a second mortgage. And with a second mortgage, equity in your home may be only partially accessible. With a cash-out refinance, you may have the option to access all of your home’s equity.
Apply at Assurance Financial
Is a remortgage or second mortgage right for you? At Assurance Financial, we can help you finance your dream home at any stage of life. We can help you get the mortgage loan you need efficiently and offer end-to-end support to ensure the process goes smoothly. Our mortgage options for homebuyers include:
- Conventional mortgage loans: If you have a stable income, good credit and a down payment, a conventional mortgage may be the right option for you.
- Second mortgages: If you are already a homeowner and want to borrow against the equity in your home without affecting your primary mortgage, you may want to apply for a second mortgage.
- FHA mortgage loans: These loans are available to moderate-income and low-income households. If you qualify for an FHA loan, you may be able to put down a lower down payment.
- VA mortgage loans: These loans are available for veterans or active service members. These loans are secured via the U.S. Department of Veterans Affairs.
- Construction loans: If you are building a new home, you may want to obtain a construction loan.
- Jumbo mortgage loans: Sometimes your dream home exceeds the limits for conforming loans. This means you may need a jumbo mortgage to finance a more expensive property.
- USDA RD mortgage loans: If you want to purchase a home in a designated rural or suburban area, you may qualify for a USDA RD
- First-time homebuyer loans: If this is your first time purchasing a home or you haven’t owned a home in the last three years, you may be eligible for a first-time home loan.
- Modular home loans: If you are purchasing a manufactured or prefabricated home, you may be able to obtain a modular home loan.
- Non-qualified loans: Also known as non-QM loans, these are available to homebuyers with lower credit scores.
Our loan advisors at Assurance Financial want to help you with your mortgage today. Contact us to learn more about the best option for you.
Sources
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