Summary: Comparing second mortgage vs. refinance for accessing home equity
From Yahoo Finance: 2024-11-11 10:00:00
If you have a significant goal, like paying off credit card debt or renovating your kitchen, you may be interested in tapping into your home equity to help you afford it. You can access your home equity — what your property is worth minus what you still owe on it — in several ways, including taking out a second mortgage or refinancing your existing mortgage loan.
A second mortgage is exactly how it sounds. You take out another home loan on your residence — in addition to your existing housing debt — and repay the two notes concurrently. Second mortgages come in two forms: a home equity loan or a home equity line of credit (HELOC).
Sometimes you can get a HELOC with only 15% equity in your home, but it’s common for both financial products to require at least 20% home equity to qualify. For example, if your home is worth $300,000, your primary mortgage balance must be $240,000 or less to secure financing.
Second mortgages typically charge higher interest rates because your lender takes on greater risk. If you default on your housing debt, your primary mortgage will be repaid first when the property is foreclosed on and sold.
With a home equity loan, you receive a lump sum at closing and begin making monthly payments pretty much immediately. Generally, home equity loans charge fixed interest rates, so your monthly payment will likely remain stable throughout the repayment term.
A HELOC has two distinct phases: the draw and repayment periods. During the draw period, which often lasts up to 10 years, you can spend up to your credit limit, pay down your balance, and repeat the process. Your HELOC lender may allow interest-only payments during this time.
During the repayment period — which typically lasts for 20 years — you can no longer use your credit line and must make principal and interest payments until the debt is paid off. HELOCs usually have adjustable mortgage rates, so your monthly payment may change during the loan term. Some mortgage lenders allow you to switch to a fixed rate during your repayment term, though.
Unlike a second mortgage, a mortgage refinance pays off your original mortgage with a new one. Your new mortgage loan will likely include a different interest rate, a new repayment term, cash back, or some combination of the three. There are two main types of refinancing: rate-and-term and cash-out.
Like a home equity loan or HELOC, you’ll need about 20% equity to be eligible for a refinance. If qualified, your interest rate may be fixed or adjustable. Since your mortgage refinance lender will be first in line to get paid should you default, you should get a lower interest rate with a refinance than a second mortgage.
With a rate-and-term refinance, you simply replace your original mortgage with a new one. You use the money from your new loan to pay off the first mortgage, then start making monthly payments toward your new mortgage. You may choose this type of refinance to lower your interest rate, change your repayment term, or both.
With a cash-out refinance, you borrow more than your original mortgage balance. You then use the difference to pay off high-interest debt, update your residence, or cover another expense. Considering a new home loan or a second mortgage? Make an informed decision by understanding the perks and pitfalls. Refinancing maintains original terms, while a second mortgage offers access to equity. Financial experts suggest refinancing if interest rates are lower, but caution against using a second mortgage as an ATM for expenses. Ultimately, the choice is yours.
Read more: How to choose between a second mortgage vs. refinance