House prices rose in 2021, but the average interest rate on mortgages was 2.9%. These low-interest rates caused a spike in home sales and led to a rise in refinances and second mortgages.
Competitive interest rates typically lead to more loan originations, which means that people consider refinancing or getting second mortgages during these times.
If you’re considering one of these options, you might wonder about the differences between a second mortgage vs. refinance. What are the pros and cons? Which is the better choice?
Here is a guide to help you learn more about both options to choose the right one for your situation.
The Basics of Second Mortgages
As you contemplate a refinance vs. a second mortgage, let’s begin by explaining the basics of second mortgages.
First, a second mortgage doesn’t affect your first mortgage. If you currently owe money on your house, it’s in the form of a first mortgage. If you get a second mortgage, you keep your first mortgage.
The second mortgage provides a second lump sum of money to you that you can use for various things. In most cases, borrowers don’t use the proceeds from a second mortgage to pay their mortgage debt.
Instead, they use this money for other purposes, including the following:
- Debt consolidation
- Home improvements or repairs
- College costs
The result of a second mortgage is that you have two mortgage payments to make instead of one.
You can choose from two main types of second mortgages:
Home Equity Loan
The first option is a home equity loan, which offers a one-time sum of money to a borrower. If you borrow the money in this form, you receive the money once only and must repay it over time.
Home Equity Line of Credit
A home equity line of credit (HELOC) is the second option. This option provides borrowers with a credit line they can access as they wish.
For example, they might first borrow 100% of the credit line. Then, after repaying it, a borrower might decide to borrow 25% of the credit line for a different purpose.
Borrowers can use the money from the credit line when there are available funds and repay it according to the repayment terms.
The Basics of Refinancing
The second option is refinancing your home. Refinancing has some similar traits as second mortgages but is not the same thing.
Refinancing a loan doesn’t involve getting or having a second mortgage. Instead, refinancing replaces your current mortgage.
The money you get through the refinancing loan pays off your current mortgage, satisfying the debt with your mortgage lender. Then, you’ll have a brand-new loan with new terms.
Some borrowers refinance with a new loan equal to their current loan. In other words, the new loan balance is around the same amount as the existing one.
Others, though, refinance for a higher amount. A person might do this to acquire cash out of the equity in their home.
For example, if you want to invest $20,000 into a new kitchen, you might refinance for $20,000 more than you currently owe.
Through refinancing, your new loan balance would then be $20,000 more, but you’d still have just one loan payment each month.
The Similarities of a Second Mortgage vs. Refinance
You can probably see the major differences between refinancing and second mortgages, but you should also understand the similarities between the two options. Here are a few:
The first similarity is that they both require liens on your house. A lienholder is a lender that issues the loan. When a lender gives a person a loan for their home, they have rights to the home.
As a result, lenders place liens on homes after issuing loans. If you sell your house, the lienholders receive payment before you receive your profit.
Access to Equity
Secondly, you can use both to access the equity in your home. However, you may need to consider a few things before assuming you have enough equity to access.
For example, you might want to ask the lender about their loan-to-value (LTV) requirements. LTV requirements tell you the percentage of your home’s value that you can borrow.
Next, you might want to consider how much mortgage you can afford. After all, it would help if you didn’t borrow more than you can afford to repay.
You can also expect to pay fees regardless of which type of loan you choose. This is because lenders charge fees for their work. They spend time evaluating and processing loans, and time is money.
Application and Paperwork
Finally, both loan types require an application and paperwork. Lenders must evaluate a person’s financial situation and home details before issuing the loans. Therefore, both have eligibility guidelines and standards.
The Pros and Cons of Second Mortgages
Next, let’s discuss the pros and cons of second mortgages. Getting a second mortgage is a great choice when you need cash out of your equity, and it’s also an excellent option for other reasons.
Benefits of a Second Mortgage
Here are three benefits to consider with second mortgages:
You Keep Your First One
First, if you like the terms of your original loan, you might want to keep them. Fortunately, you can keep your current loan terms if you get a second mortgage.
For example, if current rates are higher than your existing loan, you’ll probably want to keep your current rate.
A second mortgage offers flexibility, especially if you choose a HELOC. You can reuse this credit line whenever you want or have available credit.
You’ll pay fewer fees to acquire a second mortgage compared to refinancing. So if you want to save money on fees, this is the way to go.
Cons of a Second Mortgage
Here are two cons to consider with second mortgages:
You Keep Your First One
One downside of getting a second mortgage is that you must keep your first mortgage terms. In other words, if interest rates are lower today than your loan rate, you’ll be stuck with your current rate.
You Have Two Payments
Another downside is that a second mortgage results in having two mortgage payments. If you prefer having only one mortgage payment, you might want to refinance your loan.
The Pros and Cons of Refinances
Now, lets talk about the pros and cons of refinancing a loan. Here are the top ones to consider as you choose which option to use.
Benefits of Refinancing
Here are five of the top benefits to analyze as you decide:
You Can Change the Terms
Refinancing is ideal for saving money on interest charges when interest rates drop. You can apply for a new loan at a lower rate and instantly save money on interest.
You Have Only One Loan
Next, refinancing eliminates having two loans. Your new loan might have a higher balance than your original loan, but you’ll only have one monthly payment to make.
You Can Get Cash Out
Additionally, you can still get cash out of the loan when refinancing. If you need cash for any purpose, you can apply for a larger refinance loan than the amount you currently owe.
The lender will give you a check for the difference if they approve your loan request.
You Can Eliminate PMI
One additional benefit to consider is eliminating the private mortgage insurance (PMI) you’re currenting paying. If you refinance, you might have a better chance of eliminating this requirement.
However, if you’re choosing cash out of the refinance, you might not eliminate the PMI, as PMI depends on your LTV.
Cons of Refinancing
Here are two of the top cons of refinancing:
It Costs More
As mentioned, there are fewer fees with second mortgages. Therefore, a con of refinancing is that you might pay higher fees for this service.
It Might Take Longer
Finally, refinancing might take longer to complete. If you need your money faster, you might choose a second mortgage instead.
How to Choose the Right Option
You should have all the information you need to determine which option to choose. However, you might want to talk to a lender to learn more about both choices.
When discussing your situation, tell the lender your primary goals. From there, the lender can tell you if refinancing is a good idea or if you should choose a second mortgage.
Contact Us to Learn More
You should understand both options after reading this guide, but you might still have questions about a second mortgage vs. refinance. You may want to research both options more before choosing the one you want to use.
If you’d like more information, contact us at Influential Times. We offer both options and can help you pick the right one.