Second Mortgage Vs. Refinance: What’s The Difference?

You probably already know you can use the equity in your house to borrow money. You may also know you can do it by either refinancing or taking a second mortgage. But what you might not know is which option is best for you right now.

Let’s take a closer look at the differences between a second mortgage and a mortgage refinance. We’ll compare both options, look at their pros and cons then help you decide which path at the fork you should take when you want to access your home equity.

When you get a second mortgage, you borrow a lump sum of cash against the equity you have in your home. You can also choose to borrow your money in installments through a credit line and, if needed, you still have the option to refinance a second mortgage.

Second Mortgages And Mortgage Liens

One major condition of a second mortgage is that lenders put a lien on your home when they give you cash or a loan.

A mortgage lien is a legal claim to a property that allows the lender to seize it under certain conditions. The lender that owns your primary mortgage has the first lien on your property; your second mortgage lender has a secondary lien.

If a home goes into foreclosure, the primary lender gets its money back first, and anything left over goes to the secondary lender. This means that the secondary lender shoulders more risk for a loan.

To offset the risk, your second mortgage will have a slightly higher interest rate than your primary one. It’s vital to make sure you can make both payments. Losing your job or running into financial hardship may mean you’re more likely to lose your home.

Next, we’ll take a closer look at second mortgages, including the types along with their pros and cons.

There are two main types of second mortgages: home equity loans and home equity lines of credit. It’s important to note that with both of these types of second mortgages, you’ll make repayments in addition to your primary mortgage payment.

What happens if your primary mortgage and your second mortgage are from separate companies? You guessed it – you’ll need to pay both lenders individually.

Home Equity Loans

A home equity loan is a type of second mortgage that lets you borrow against the equity in your home with a lump-sum payment. You then pay back the loan in monthly installments with interest at a fixed rate.

Rocket Mortgage^® is now offering its Home Equity Loan, which is available for primary and secondary homes.

Home Equity Lines Of Credit

A home equity line of credit (HELOC) is a type of second mortgage that acts similar to a credit card, giving you continuous access to funds at a variable rate.

You’ll start out with a draw period when you take out a HELOC. During this time, you can usually spend up to your credit limit without having to make any payment aside from your accumulated interest. You pay back the remaining balance in monthly installments after the draw period ends.

Rocket Mortgage does not offer HELOCs at this time.

When it comes to second mortgages, it’s important to learn the advantages and disadvantages that go along with them. Let’s take a look to learn whether a second mortgage might be the best option for you.

Advantages Of Taking Out A Second Mortgage

Some benefits of taking on a second mortgage include:

• Flexibility: You can often choose how you get your money by picking between a home equity loan and a HELOC. If you need a lump sum, you’ll usually choose a home equity loan. On the other hand, if you have an ongoing project, like a home renovation, a HELOC gives you access to a credit line. This freedom of choice isn’t available when you refinance.
• Fewer closing costs: Home equity loan providers typically cover all or most of the closing costs associated with getting your loan. This can potentially save you thousands of dollars, as closing costs for refinances usually range between 2% – 6% of the total loan value.

Disadvantages Of Taking Out A Second Mortgage

Some drawbacks of taking on a second mortgage include:

• Additional lien: Taking on another lien to your property puts you at an increased risk of foreclosure if you can’t consistently pay both lenders.
• Two monthly payments: You’ll shoulder an extra monthly payment. You’ll need to pay your primary mortgage and second mortgage each month. Missing a payment can put you at risk of losing your home.
• Can’t improve first mortgage terms: You don’t have the option to change your original mortgage terms. Your second mortgage has no impact on your original mortgage loan. You can’t change your primary loan’s term or interest rate with a second mortgage.

Now that we’ve covered what a second mortgage is, the types, and the pros and cons, let’s take a closer look at what it means to refinance your loan.

When you refinance, you replace your primary loan with a new loan. This allows you to choose a new lender, change your loan term, take a new interest rate or even take on a new type of loan.

You can choose from different types of refinancing options. But before we get into them, let's look at what goes into the process of applying for a refinance.

Applying for a refinance is very similar to your home purchase mortgage application. You’ll submit financial documentation to your lender first, and they’ll underwrite your loan. In most cases, you’ll also need to get an appraisal before you can refinance.

After the underwriting and appraisal processes are complete, you’ll close and sign on your new loan. Keep in mind that you won’t get your money until a few days after closing if you take a cash-out refinance.

Rate And Term Refinances

Rate and term refinances allow you to change how your loan is set up without affecting your principal balance.

You can lower your monthly payment by taking a longer term, or you can own your home faster and save on interest by shortening it. You can also refinance to a lower interest rate if market rates are lower now than when you got your loan.

Cash-Out Refinances

Cash-out refinances allow you to access your home’s equity in exchange for taking on a higher principal.

For example, let’s say you have a loan with a $100,000 principal balance and you want to do $20,000 worth of repairs on your property. You’ll accept a loan valued at $120,000. Your lender then gives you the $20,000 in cash a few days after you close.

If you’re planning on refinancing, knowing the advantages and disadvantages that go with it are important when choosing. Let’s look at the pros and cons of refinancing.

Advantages Of Refinancing

Some benefits of refinancing include:

• Change your existing loan’s rate and term: You can adjust your rate and term with a refinance, which can come in handy if you’re having trouble making your monthly mortgage payments. You don’t have this option if you only take a second mortgage.
• Single monthly mortgage payment: When you refinance, you replace your current mortgage loan with a new loan. This means that you only need to worry about making a single payment each month.
• Lower your interest rate: One lien on your property equals less risk for the lender. This means that interest rates are usually lower on cash-out refinances than second mortgages.

Disadvantages Of Refinancing

Some drawbacks of refinancing include:

• Higher closing costs: You’re responsible for covering all of your closing costs when you refinance. Closing costs on refinances are typically 2% – 6% of your loan’s total value. While it’s possible to roll your closing costs into your loan, this option also increases your monthly payment.
• Forfeit your current interest rate: Your lender might require you to accept an interest rate that’s close to the current market rates. You could lose money if rates are higher now, or if you originally locked into a loan with exceptionally low rates.

Choosing between a second mortgage and refinancing is different when it comes to each person and their financial situation. If you’re not sure, let’s look at some of the reasons you might choose one option over the other.

When Should You Refinance?

If you want to change your loan’s rate or term, you should choose to refinance. This is because you’re unable to change the terms of your loan with a second mortgage.

A cash-out refinance might be right for you if your goal is to consolidate debt or need to pay for a large expense and you have plenty of equity. You’ll need to cover closing costs, but interest rates are lower on cash-out refinances compared to second mortgages.

When Should You Get A Second Mortgage?

If you need a lump sum of cash but you don’t want to change your mortgage terms, a second mortgage could be the best choice for you. You’ll pay a bit more in interest on a second mortgage than your primary loan, but you’re guaranteed to keep your current interest rate on your primary loan. This isn’t always guaranteed when you refinance.

It’s important to remember that you can’t access all the equity in your home, whether you choose a second mortgage or a refinance. For example, let’s say your mortgage balance is $200,000 and your home is appraised at $300,000. You have $100,000 in equity, but your lender might give you the option to access a maximum of 80% of your home’s appraised value or $240,000. This means you would be able to borrow $40,000.

The amount of equity you must leave in your home depends on a variety of factors, including your lender, your credit score and your current debt-to-income ratio.

A second mortgage is a loan or line of credit you take against your home’s equity. Although they allow you to use equity without altering the terms of your original mortgage, they also add another payment to your monthly budget and often have higher interest rates. Second mortgages are best if you already have a good interest rate on your mortgage and need extra funds for a home repair.

Refinancing allows you to access equity without adding another monthly payment. However, you’ll also need to pay more at closing to finalize your new loan. Cash-out refinances are best for consolidating large amounts of debt. You can change your loan’s rate or term when you refinance.

Think a refinance is the best option for your situation? Start the refinance process today with help from Rocket Mortgage.