Refinancing A Second Mortgage: What You Need To Know
Dan Rafter7-minute read
April 21, 2021
You know that refinancing your mortgage can leave you with a new loan with lower interest rates and smaller monthly payments. If you lower your interest rate by enough, you could shave hundreds of dollars off your payment.
But what if you have a second mortgage, too, maybe a home equity loan or home equity line of credit? Can you refinance those mortgages? And can you combine both your primary and second mortgages into one loan?
You can. But you’ll have to meet certain requirements.
What Is A Second Mortgage?
As its name suggests, a second mortgage is any mortgage other than your primary mortgage loan.
There are several types of second mortgages available to homeowners. You might take out a home equity loan. This is similar to your primary mortgage, but the amount you can borrow is based on your home’s equity. Equity is the difference between what you owe on your mortgage and what your home is worth. If your home is worth $200,000 and you owe $120,000 on your mortgage loan, you have $80,000 in equity.
You can then take out a second mortgage loan – a home equity loan – against that equity, borrowing, say $60,000. You’ll receive that money in one lump payment that you pay back in monthly installments with interest, just like you do your primary mortgage. You can use that money for anything. If you use it to fund a home improvement that increases the value of your home, you can write off the interest you pay on your income taxes.
You can also take out a home equity line of credit, better known as a HELOC. The amount you can borrow through a HELOC is again based on your home’s equity. But a HELOC acts more like a credit card with a maximum credit limit based on this equity amount. Say you have $80,000 of equity. You can take out a HELOC with a borrowing limit of $60,000. You then pay back only what you borrow. You might only borrow $30,000. You’d then have to pay this back, with interest, in monthly installments.
Finally, there are piggyback mortgages. Borrowers might take these out to avoid paying private mortgage insurance, or PMI, an insurance that protects lenders and can add hundreds of dollars to borrowers’ mortgage payments. These are also known as 80-10-10 loans. That’s because borrowers cover 80% of the home’s cost with a standard first mortgage loan. They cover the second 10% with a second mortgage loan, usually a home equity loan or HELOC. They pay for the final 10% of the home’s price with their down payment.
Can You Refinance A Second Mortgage?
You can refinance your second mortgage. Some homeowners might want to refinance both their first mortgage and their home equity loan or HELOC into one mortgage loan. This will leave them with one monthly payment instead of two. And if their new interest rate is low enough, they might also reduce the amount they pay each month in mortgage dollars.
The challenge lies in home equity. Most lenders require that borrowers have at least 20% equity in their homes to refinance their mortgage. Borrowers, then, will need enough equity to reach that percentage even though they are refinancing two mortgages.
It’s also possible to refinance only your second mortgage. You might, for instance, want to refinance a HELOC with an adjustable interest rate – one that changes over time – to home equity loan with a fixed rate that remains the same, making it easier to budget for your monthly mortgage payment. It’s important to note that Rocket Mortgage® does not offer refinances on second mortgages solely, but can help refinance when a secondary loan will be rolled into the primary loan.
Can You Refinance A Primary Mortgage When You Have A Second Mortgage?
You can still refinance your primary mortgage even if you have a second loan on your home. That second mortgage just makes the process more complicated.
There are two ways to close a refinance of a primary mortgage when you have a second mortgage: You can refinance both your primary and second mortgages into one loan. Say you owe $150,000 on your primary mortgage and $50,000 on your second mortgage. You'd need to refinance the two loans into one loan of $200,000, or more if you are rolling closing costs into your new loan. If you don't have 20% equity in your home, you won't be able to do this.
But what if you want to keep that second loan? Maybe your second loan is a HELOC and you like the flexibility of having a line of credit against your home's equity. You can refinance your primary mortgage if the lender who holds your second mortgage agrees to what is known as resubordination.
Under this process, the lender of your second mortgage agrees to remain in the second, or subordinate, position after you refinance your existing primary mortgage. Usually, your second mortgage would become your primary loan after such a refinance because it is the older debt. You'll need to request, then, that the holder of your second loan agrees to waive this position and remain in the second or subordinate position after your refinance closes.
If the lender doesn't agree to this, you won't be able to close your refinance and keep that second loan: No mortgage lender giving you a primary mortgage loan will agree to the subordinate position.
Fortunately, most lenders will agree to resubordination. You'll usually have to pay a small fee and submit some paperwork to this lender to make the resubordination happen.
Pros And Cons Of Refinancing A Second Mortgage
Refinancing can save you money. But that doesn’t mean there aren’t both pluses and negatives involved with this financial move.
Lower your monthly payment: The most common goal of refinancing any mortgage is to lower your monthly payment. You do this by refinancing to a new mortgage that has a lower interest rate. That lower rate will give you a lower monthly payment. It’s true that second mortgages generally aren’t as large as primary loans. But reducing the rate on a second mortgage can still bring solid savings each month.
Switch from two payments a month to one: If you have both a second and first mortgage, you’ll also have two payments to make each month. This can complicate your bill-paying routine and might increase the chance that you’ll accidentally forget to make one of your payments. By refinancing your first and second mortgages into one loan, you’ll eliminate one of your payments each month.
Eliminate that adjustable-rate mortgage: Maybe your second mortgage features an adjustable rate, one that rises or falls depending on the performance of certain economic indexes. These fluctuations can cause your mortgage payment to rise or fall, too. If you want more certainty, you might refinance your adjustable-rate mortgage into a fixed-rate loan.
Refinancing isn’t free: Though it varies by lender, you can expect to pay from 2% to 5% of your loan’s principal balance in closing costs. You’ll have to determine, then, if you can lower your interest rate by enough to generate high enough savings to pay back these costs quickly.
Missing payments could mean you’ll lose your home: Any time you take out a new mortgage, whether it’s through a refinance or by taking out a purchase mortgage when you buy a new home, you put yourself at increased risk of losing your home. That’s because if you stop making your mortgage payments, your lender can take ownership of your home through the foreclosure process.
How To Refinance A Second Mortgage
If you’re ready to refinance your second mortgage – maybe by refinancing a HELOC into a fixed-rate loan – the first step is to shop for a mortgage lender. You can refinance with your current lender, either the one that originated your primary mortgage or the one behind your second. But you don’t have to. You can refinance with any lender licensed to do business in your state.
Prove Your Income
Once you settle on a lender, you’ll most likely need to provide it with certain documents that prove you have enough income to make your payments on time. These documents can include copies of your last two paycheck stubs, last 2 months of bank account statements, tax returns from the last 2 years and your W-2 forms from the last 2 years.
Your Credit Score
Your lender will study these documents and will also consider several key numbers. Lenders will look at your three-digit credit score to make sure you have a history of paying your bills on time. The higher this score, the more likely you are to earn approval for your refinance request. Lenders consider FICO® Scores of 740 or higher to be excellent ones. You’ll need a strong score to nab an interest rate low enough to make refinancing worthwhile.
Your Debt-To-Income Ratio
Your debt-to-income ratio, also known as your DTI ratio, is also key. This ratio looks at the relationship between your monthly debts and income. Most lenders want your total monthly debts, including your new mortgage payment, to equal no more than 43% of your gross monthly income. There is some leeway here, though, as different lenders might be more willing to work with borrowers with higher debt-to-income ratios.
Your loan-to-value ratio, or LTV ratio, is another important factor in your refinance. As the name suggests, your LTV is the ratio of how much you owe on your current mortgage loan – or loans – divided by the current value of your home. If your home is valued at $150,000 and your combined mortgages equal $90,000, your LTV is 60%.
Most lenders require that you have at least 20% in equity to qualify for a refinance. This, then, means you'll need an LTV of 80% or less.
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