There will come a time when most of us need extra cash. It could be for any number of things, but the point is that you may not have the cash resources to meet your need. The one resource that you do have is your home. If you are in this situation you must decide: Do I need a second mortgage or should I refinance my current loan?
This is a loaded question with many possible answers. Some see a second mortgage as compounding new debt on top of old. They see refinancing a current loan like mixing up the letters in a word and putting them in a new order. It could be just the terminology that has people choosing one over the other. Here is a bit of fact to straighten things out.
Refinancing and second mortgages are both loans. No matter how you slice it, you will be assuming another loan if you choose to do either of these things. Now, a second mortgage is just what the name implies — another mortgage loan on your home that already has a mortgage lien against it.
A second mortgage can’t be equal to the amount of the first loan. And hopefully you won’t need that much money. Since the purchase price of the home was the basis for the first loan, the equity that you have built into your house is the basis of a second mortgage. Equity equals the difference between the appraisal price of your home and how much you have paid towards the first mortgage.
Interest rates are higher for second mortgages. There is a greater chance of default. And if you default, the primary mortgage will be paid off first before considering any payments on the second mortgage. To finance the second mortgage, lenders offer a fixed or an adjustable rate equity loan. Which one you qualify for depends on your credit score, the market, and you ratio of loan total to value.
Second mortgages are primarily used when there is a large amount of debt to be settled. It could be credit cards, car payments, or other costs like medical bills. Second mortgages can be a source of capital for a cash investment in business or another property for personal use.
Refinancing can be an option for homeowners who are not necessarily looking for a large cash payout. In this instance, you are restructuring an existing loan on your home. Refinancing offers the convenience of a single payment each month like you were already used to.
Let’s say that your credit was such that you qualified for an adjustable rate mortgage. Over time, the percentage has adjusted where you are paying $300 more dollars a month on your mortgage payment. Now that your credit is better, you can refinance that loan for a lower fixed interest rate mortgage and get out from under those high payments.
Refinancing can involve going from a 30 year mortgage to a 15 year mortgage. Maybe you can afford the payment increase and want to pay off the home loan quicker and gain equity faster. Some want funds for home improvement or to consolidate existing debt.
Both a second mortgage and a refinanced first mortgage have options for different money issues. However, unless you have built substantial equity in your home, try to refinance before taking out a second mortgage.