If you have equity in a home that you want to use, you have two options – refinance your first mortgage or take out a second mortgage. These options each have basically the same outcome. You get the cash in hand. How do you determine what’s right when choosing refinancing vs a second mortgage?
The answer is that each option has its pros and cons. Keep reading for our outline of the differences below.
Refinancing affects your current mortgage. You effectively replace this mortgage with a new (larger) mortgage. Let’s say, for example, the home you own is worth $250,000. Right now you have a $100,000 mortgage on it because you made a large cash down payment when you bought the home. Maybe you’ve run into trouble and need more money to continue renovations or you decided to expand your real estate portfolio.
You have $150,000 in equity in the home – that’s plenty to tap into and meet the loan-to-value requirements. Most lenders allow up to an 80% loan-to-value ratio on a cash-out refinance. This leaves you with $100,000 available, assuming you qualify for the full amount.
If you want the $100,000, you need a new first mortgage. You’ll go through the same process you did when you bought the home, verifying your income, assets, liabilities, credit score, and the home value. If you qualify, the lender will pay off your existing loan and pay you the difference ($100,000). Now you have a new first mortgage with a new lender and a new mortgage payment.
Understanding A Second Mortgage
The second mortgage has the same outcome but works differently. Rather than paying off your first mortgage, the second is an additional mortgage. You pay a separate lender (or your same lender if you choose) on a second loan.
When looking at refinancing vs a second mortgage, you may find second mortgages have higher loan-to-value options. First mortgage lenders stick to the 80% rule because they have strict investor guidelines. Second mortgage lenders often keep the loans on their books, meaning they don’t have any investors to answer to. If they feel you qualify for a higher LTV than 80%, they may grant it as long as you prove you can afford it.
The second mortgage leaves your first mortgage untouched. Using the above example, let’s say you borrow a $ 100,000-second mortgage. You’d have a separate payment from your payment on the first $100,000 mortgage.
Second mortgages often have different terms. For example, a home equity line of credit works like a credit card. You receive a credit line that you can draw from as needed. You only owe interest on the money you withdrew and principal payments aren’t required for the first ten years. A home equity loan is a fixed-rate loan that provides your proceeds in one lump sum. You make the same principal and interest payment for the term, which is usually 20 years.
Refinancing Vs Second Mortgage – Which Is Right For You?
Choosing between refinancing vs a second mortgage depends on the factors. Ask yourself the following questions.Are you looking for a lower interest rate?
If your first mortgage interest rate is higher than current rates, you may tap into your home’s equity and lower your interest rate simultaneously. You may even find your mortgage payment stays about the same even while you tap into your home’s equity.Are you looking to expand your real estate portfolio?
Many investors start investing by tapping into their primary residence’s equity. If you have a great interest rate/term on your first mortgage, consider taking out a second mortgage for your new venture. You won’t lose the great terms on your first mortgage and yet you can expand your investments and potential profits.Do you want a line of credit?
If you don’t have a fixed number in mind when taking equity out of your home, a line of credit may provide the flexibility you need. You can have the money available, but don’t have to draw it or pay interest on it if you don’t use it. You get the best of both worlds.
What Should You Choose?
Refinancing vs a second mortgage is an age-old debate. Think about the reasons you need the funds and what you want to do with them. Also, evaluate your first mortgage situation. If you’ve paid it down significantly and have a great interest rate, there’s no reason to touch it now when you have many second mortgage options at your disposal.