Second Mortgage Vs. Refinance: Your Guide

Is refinancing the same as getting a second mortgage?

Cash refinances and second mortgages are similar in that both types of financing allow you to use the equity you have built up in your home. However, the two options differ in how they affect your existing mortgage and your monthly payments.

For example, a refinance pays off your current mortgage and replaces it with a new home loan. The interest rate, loan term and mortgage payment amount are subject to change. But since you will still only have one mortgage and one lien, you will continue to make only one monthly mortgage payment.

However, a second mortgage will not replace or change your existing mortgage. You will continue to pay your first mortgage as scheduled. But because you are now responsible for a second mortgage, you will have an additional loan payment to make each month.

Let’s dive a little deeper into each financing option.

Refinancing by withdrawal

A basic rate and term refinance is all you need to change the mortgage rate or the term of your mortgage. However, if you also want to tap into the equity in your home so you can consolidate some debt or start investing, you will need to use cash refinancing.

A cash-out refinance is a type of mortgage refinance in which you replace your existing mortgage with a larger mortgage and your lender gives you the difference in cash. Most lenders require you to have an 80% loan-to-value (LTV) ratio, which means you’ll need to retain 20% of your home’s equity when you refinance.

Here’s how it works: Say your home is appraised at $250,000 and you have a net worth of $75,000. You would be able to cash out up to $60,000 of your home equity.

However, let’s say you only need $25,000 for a home improvement project. You could get a $200,000 loan to replace your current mortgage balance of $175,000, and your lender would give you the $25,000 in cash within 3-5 days of closing.

Second mortgage

If you choose to take out a second mortgage to access the equity in your home, you have two options:

  • Home Equity Loan: This type of second mortgage allows you to borrow a lump sum in exchange for the equity you have built up in your home. Like a home loan or personal loan, you typically pay off 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 the equity in your home. Instead of receiving these funds in a lump sum, however, you will receive the money as a line of credit similar to a credit card. During the draw period, you can borrow, repay, and re-borrow from the line of credit as needed as long as you don’t go over the limit. At the start of the repayment period, you will no longer be able to draw on the line of credit and you will have to make regular payments until you have repaid the borrowed money.

With a home equity loan, you’ll typically borrow at a fixed interest rate, while a HELOC typically carries a variable rate. Like cash refinances, home equity loans and HELOCs generally have limits on the amount of equity you can draw on.

When to use a second mortgage

Home equity loans work well for debt consolidation because you’ll likely have a pretty good 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 are unsure of the exact amount you will need to use.

Currently, Rocket Mortgage® does not offer HELOC.

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