You have a sizable amount of home equity and want to convert it into cash. A second mortgage, like a home equity loan or home equity line of credit (HELOC), could be a viable option, or you could opt for a cash-out refinance. But how do you know which option is most ideal for your financial situation?
Keep reading to learn more about the specifics of second mortgages, how they differ from refinances, and the key benefits and drawbacks. This guide also discusses factors to consider when deciding between a second mortgage and refinance to access the cash you need.
Is a Second Mortgage the Same as a Refinance?
Second mortgages and refinances can accomplish similar objectives, but they aren’t quite the same. Here’s a closer look at the differences between the two.
What is a Second Mortgage?
A second mortgage is a type of loan that allows you to borrow against the value of your home beyond what you owe on your primary mortgage. Home equity, the difference between your home’s market value and your mortgage balance, serves as collateral for this loan.
There are two primary types of second mortgages – home equity loans and home equity loans of credit (HELOC). Home equity loans provide a lump sum, and a home equity line of credit (HELOC) works like a credit card by giving you a credit line from which to draw as needed.
What is a Refinance?
A refinance involves replacing your existing mortgage loan with a new loan, generally with varying terms. By doing so, you could get a lower interest rate or change your loan terms.
A cash-out refinance is also an option, as it lets you take out a portion of your home’s equity as cash. You can get a new, larger mortgage that exceeds the amount you currently owe – the difference is disbursed to you at closing.
Pros and Cons of Second Mortgage and Refinance
Advantages of a Second Mortgage
- Access to cash: A second mortgage allows you to borrow against the equity you have built in your home, providing a lump sum of cash that can be used for various purposes.
- Preserve low interest rates: If your first mortgage has a lower interest rate than current rates, a second mortgage enables you to borrow additional funds without altering the terms of your original loan.
Disadvantages of a Second Mortgage
- Higher interest rates: Generally, second mortgages come with higher interest rates compared to first mortgages, meaning you’ll pay more over the life of the loan.
- Additional monthly payments: You will have the responsibility of making two monthly payments – one for your original mortgage and one for your second mortgage.
Advantages of Refinancing
- Potential for lower interest rates: Refinancing can provide you with a new mortgage at a lower interest rate, which could reduce your monthly payments and the total interest paid over the life of the loan.
- Opportunity to adjust loan term: Refinancing affords you the opportunity to modify your loan term. You can shorten it to pay off your loan sooner or extend it to lower your monthly mortgage payments.
Disadvantages of Refinancing
- Closing costs: Refinancing your mortgage involves paying closing costs, which can be significant and should be considered when calculating potential savings. They’re generally equal to 2 to 6% of the loan amount.
- Possibility of higher rates: Refinancing could result in a higher rate if interest rates have increased since your original home loan. In this case, you’ll incur steeper borrowing costs over the life of the loan.
What is the Difference Between a Second Mortgage vs Refinance?
Below is a closer look at the key differences between second mortgage and home loan refinances.
Purpose
A second mortgage allows you to borrow against the equity of your home to obtain funds for various needs without altering your primary mortgage. By contrast, refinancing your mortgage typically aims to modify the terms of your existing loan, possibly to achieve a better interest rate or convert from a variable to a fixed rate. Or you can take out additional cash by extending the loan amount based on your home’s equity.
Requirements
To qualify for a second mortgage, you need to have sufficient equity in your home, as it serves as collateral for the loan. Lenders will consider your credit score, income and the loan-to-value (LTV) ratio. Credit score and home equity requirements are similarly assessed for refinancing. Still, you will also need to meet additional lending criteria that may be more stringent, as the new loan will replace the original mortgage.
Interest Rates
Second mortgages are riskier for lenders. So, to protect their interest, many often offer them with higher interest rates than you’ll find on first (or primary) mortgages.
Repayment Terms
You’ll generally get a shorter term on a second mortgage. However, refinancing could lengthen or shorten your current loan term, depending on what you’re trying to accomplish.
Credit Score Impact
Both taking out a second mortgage and refinancing can affect your credit score initially due to the necessary hard inquiries. However, as long as you make timely payments, either option can positively impact your credit over time. Managing two separate mortgages may be more complex, and any slip-ups could hurt your credit score more with a second mortgage.
Other Financial Implications
Besides interest rates and repayment terms, consider other costs, such as closing fees and potential tax implications. Second mortgages tend to have lower closing costs but often have higher interest rates. With a refinance, you might get a better rate but will likely incur higher closing costs, eroding some of the savings. Additionally, the deductibility of interest paid may vary between the two options, impacting your overall financial situation.
A Second Mortgage is Better for You If…
- You need a lump sum of cash: If you need to access a significant amount of money all at once, perhaps for a major renovation or to consolidate high-interest debt, a second mortgage allows you to borrow against the equity you’ve built in your home as a lump sum.
- Your current mortgage rate is favorable: If you have a first mortgage with a low interest rate, it may be beneficial to leave it intact and opt for a second mortgage to avoid refinancing at a higher rate.
- You want to avoid refinancing costs: Taking out a second mortgage can be cost-efficient since you’re not changing the terms of your existing mortgage, thereby avoiding the fees associated with refinancing.
A Refinance is Better for You If…
- You’re seeking a lower interest rate: Refinancing might be the right choice if you can secure a new loan with a lower interest rate than your current mortgage. A lower rate could significantly reduce your monthly payments and the total cost of your loan over time.
- Your credit score has improved: If your credit score has gone up since you took out your original mortgage, you may qualify for more favorable refinance terms. This could include a reduced interest rate or better loan features.
- You want to change your loan term: Refinancing allows you to adjust the term of your loan. Shortening your loan term can increase your monthly payments but may decrease the total interest paid. Conversely, extending your loan term can lower your monthly payments but increase the interest paid over the life of the loan.
- You desire a fixed rate: If you currently have an adjustable-rate mortgage (ARM) and you prefer the predictability of a fixed rate, refinancing into a fixed-rate loan can protect you against future interest rate hikes.
- You want to consolidate debt: You can use the loan proceeds from a cash-out refinance to consolidate high-interest debt. Doing so means you’ll get a single monthly payment, and you could free up room in your budget and use the funds to meet other pressing financial goals.
Conclusion: How to Choose Between a Second Mortgage vs Refinance
A second mortgage could be ideal if your current mortgage has a low interest rate or you need a lump sum for a specific purpose, such as debt consolidation or home improvements. But if your objective is lower monthly payments or if you want different loan terms, you could be better off refinancing your current mortgage.
Be sure to assess the pros and cons of each and speak with the mortgage lender before formally applying. You want to ensure you fully understand the terms and conditions of the loan you’re considering so you can make an informed decision.
FAQs About Second Mortgage vs Refinance
Yes, you can pull equity out of your house without refinancing by obtaining a second mortgage.
This could come in the form of a home equity loan or a home equity line of credit (HELOC). A second mortgage allows you to borrow against the value of your home above what you owe on your first mortgage.
Whether it’s better to get a second mortgage or refinance your current home loan depends on your financial situation. Refinancing could mean a lower interest rate, different terms and more affordable monthly payments. But if you want to keep your existing mortgage intact or if you need cash and don’t mind an additional monthly payment, a second mortgage could be ideal.
Yes, you can avoid having to take out a second mortgage when refinancing to access cash. This is done through a cash-out refinance and involves swapping out your original mortgage with a new one for a larger amount, potentially with better terms and rates. The difference is disbursed to you after closing in cash.
