Is Refinancing The Same As Getting A Second Mortgage?
Cash-out refinances and second mortgages are similar in that both types of financing allow you to use the equity you’ve built in your home. However, the two options differ in how they affect your existing mortgage and monthly payments.
For instance, a refinance pays off your current mortgage and replaces it with a new home loan. The interest rate, loan term and mortgage payment amount can change. But because you’ll still only have one mortgage and one lien, you’ll continue making only one monthly mortgage payment.
On the other hand, a second mortgage will neither replace nor change your existing mortgage. You’ll keep paying on your first mortgage as planned. But because you now are responsible for a second mortgage, you’ll have an additional loan payment to make each month.
Let’s dive a little deeper into each financing option.
A basic rate-and-term refinance is all you need to change the mortgage rate or loan term of your mortgage. However, if you also want to tap into your home equity so you can consolidate some debt or start investing, you’ll need to use a cash-out refinance.
A cash-out refinance is a type of mortgage refinance where you replace your existing mortgage with a larger mortgage and your lender gives you the difference in cash. Most lenders require you to have a loan-to-value ratio (LTV) of 80%, meaning you’ll be required to keep 20% equity in your home when you refinance.
Here’s how it works: Let’s say your home is appraised at $250,000 and you have $75,000 in equity. You’d be able to cash out up to $60,000 of your home’s equity.
However, let’s say you only need $25,000 for a home improvement project. You could get a loan amount of $200,000 to replace your current mortgage balance of $175,000, and your lender would give you the $25,000 in cash within 3 – 5 days after closing.
If you elect to take out a second mortgage to access your home’s equity, you have two options:
- Home equity loan: This type of second mortgage loan allows you to borrow a lump sum in exchange for the equity you’ve built in your home. Like a home loan or personal loan, you’ll typically repay a home equity loan in monthly installments.
- Home equity line of credit (HELOC): Much like a home equity loan, a HELOC lets you borrow money against your home equity. Instead of receiving these funds in a lump sum, however, you’ll receive the money as a line of credit similar to a credit card. During the draw period, you can borrow, repay and borrow again from the line of credit as needed as long as you don’t exceed the limit. When the repayment period begins, you’ll no longer be able to draw from the credit line, and you’ll need to make regular payments until you’ve repaid the money you borrowed.
With a home equity loan, you’ll typically borrow at a fixed interest rate, while a HELOC usually carries a variable rate. Like cash-out refinances, both home equity loans and HELOCs typically have limits on the amount of equity you can tap into.
When To Use A Second Mortgage
Home equity loans work well for debt consolidation because you’ll probably have a pretty solid understanding of the exact dollar amount you need to borrow. Home equity loans can also work well when you’re tackling a single renovation or repair project, such as replacing a roof or remodeling a kitchen or bathroom. You’ll just want to make sure you get quotes from multiple contractors so you know exactly how much to borrow.
However, a HELOC may be a better option if you need funds for several ongoing home improvement projects or you’re otherwise unsure exactly how much equity you’ll need to use.
At this time, Rocket Mortgage® doesn’t offer HELOCs.