Refinancing second mortgages can help you save money on your loans. Read on to find a step-by-step guide on how you can do this.
As a property investor, loans can help you kick off your real estate empire even if you are starting with a small amount of capital. When buying your first rental property, you would take out a home loan. If you still need funds to renovate or buy another property, getting a second mortgage would help.
But if you take out a second mortgage, then you would have to manage two monthly payments. Having two outstanding loans might affect your income from your investments as well. Can you renegotiate your terms, or do you just have to live with them?
In this article, you will learn all about the second mortgage, its different types, and the possibility of refinancing it. You will also read about the pros and cons of refinancing second mortgages, when you should do it, and how you should go about it.
What Is a Second Mortgage?
Like its name suggests, a second mortgage is any mortgage that you took out besides your primary mortgage. When you take out a home loan from a lending institution, you usually need to put up the property that you are purchasing as collateral. This home loan is called a mortgage or primary mortgage.
As you repay your loan in monthly installments, the property’s value and equity increase. Home equity is the difference between the property’s current market value and any remaining mortgage payments you need to make. Your investment property must also have a decent amount of equity–at least 20%–before you can be eligible for a second mortgage loan.
Like your home loan, you also have to pay the closing costs upfront when taking out a second mortgage. So you have to make thorough computations before deciding on whether to take out another loan. You can use an investment mortgage calculator to budget these costs. Mashvisor puts this tool at your disposal to help you estimate your spending and investment.
In case you default on both loans, the original mortgage would receive all proceeds from the property’s liquidation until it is all paid off. Meanwhile, the second mortgage would receive repayments only after the first one has been satisfied. This is why the second mortgage tends to charge a higher interest rate and lend a smaller amount compared to the first. Real estate investors often take out a second mortgage for financing the costs of increasing the value of their rental homes.
Types of Second Mortgages
There are three primary types of second mortgages you can get, depending on your needs:
Home Equity Loans
A home equity loan is one of the most popular second mortgage products. It allows you to borrow a percentage of your home’s equity in a lump sum. You can then use it to pay off high-interest debt, make improvements to your property, buy another house, and more.
The amount you can borrow is partially based on a combined loan-to-value ratio of 80% to 90% of your property’s current value. Home equity loans generally have a fixed interest rate and fixed monthly payments along with a set repayment period.
Home Equity Line of Credit (HELOC)
HELOC is another type of second mortgage that allows you to access a part of your property’s equity as you need it through a revolving credit line. Depending on your creditworthiness and the amount of your outstanding primary mortgage, you may be able to borrow up to 85% of your home equity.
HELOCs generally have variable interest rates. This means that your monthly payments are lower than you would have with credit cards and unsecured debt. But they may go up during the rest of the repayment period. However, you only need to worry about this when you withdraw any funds.
A piggyback loan can come in the form of either a home equity loan or a HELOC. You can take this out during the homebuying process, and it will let you make smaller down payments to split your home purchase between two loans. By doing this, you may be able to get approved for a home loan that you might not have otherwise qualified for.
Homebuyers try to get a piggyback loan when they want to avoid buying private mortgage insurance (PMI). This is something that primary mortgage lenders require if the homebuyer cannot afford to make a 20% down payment.
Can You Refinance a Second Mortgage?
Yes, refinancing second mortgages is possible. Some real estate investors even try to refinance both primary and secondary mortgages so they can roll them into one mortgage loan. This will leave them with one monthly payment instead of two. Doing this might also lower the interest rate, thereby reducing the amount they have to pay each month.
The challenge, however, is how much you could borrow from refinancing second mortgages, which will depend on your home equity. Most lenders require borrowers to have at least 20% equity in their property before they can proceed with refinancing second mortgages.
Refinancing a Primary Mortgage When You Already Have a Second Mortgage
You can also refinance your primary mortgage even if you already have a second loan in your home. But because of your existing second mortgage, the process becomes more complicated. There are two ways to do this:
- Refinance both first and second mortgages into one loan. You will need to have 20% equity in your property to be able to do this.
- Ask your second mortgage lender to remain in the second, or subordinate, position after you refinance your existing primary mortgage.
Advantages and Disadvantages of Refinancing Second Mortgages
When you refinance your second mortgage, you might be able to save money. But there are also negative consequences in making this financial move.
Pros of Refinancing Second Mortgages
- You can lower your monthly payment. By refinancing either first or second mortgage, your could lower your loan’s interest rate or extend your loan term and save money for the rest of the repayment period.
- You can simplify your monthly payments. When you combine your primary and secondary mortgage loans into one account, you only need to think about one interest rate, one monthly payment, and one balance.
- Lock in a fixed interest rate. Having a second mortgage with a variable interest rate may be beneficial during certain times, but they also pose a greater risk to you and may cost you a lot more in the end.
Cons of Refinancing Second Mortgages
- You will have to pay fees for refinancing. Your lender will require you to pay certain closing costs and fees, which might not offset the money you thought you would save.
- Refinancing can impact your credit score. When you refinance your mortgage payments, you technically close one mortgage account and open another one, which can temporarily affect your credit score.
- You could lose your home for missing payments. Any time you take out a mortgage or refinance an existing loan, you increase your risk of losing your property.
When to Refinance a Second Mortgage
There are several reasons for a property investor to want to refinance their second mortgage. Here are some common situations when it could make sense for you to do it:
Refinance Two Mortgages Into One
If you have a second mortgage loan, you are already juggling two monthly payments. By combining the first and second balances, you are rolling both debts into one new loan. Your lender may approve or reject this application depending on your credit score, debt-to-income (DTI) ratio, total loan-to-value (LTV), and other factors.
Lower Your Monthly Payment
Second mortgages tend to have higher interests than the first since these lenders take on higher risk as the secondary lien on your property. But if your credit score has improved, you can apply to lower your interest rate.
Lock-In a Fixed Interest Rate
A fixed-rate loan has the same interest rate for the entirety of the borrowing period, while a variable-rate loan has an interest rate that changes over time depending on the market. If you took out a second mortgage that has a variable interest rate, refinancing it will allow you to lock in a fixed rate instead, which can save you a lot of money in the end.
How to Refinance Your Second Mortgage
Step #1: Decide if a Second Mortgage Refinance Is Right for You
Using an investment mortgage calculator, you can estimate the fees you have to pay upfront and the time it will take your investment to turn a profit. If you do not have the cash readily available, or if the savings you get from a lower interest rate will not be equal to or greater than the fee, then it may not be the right time to refinance.
Step #2: Evaluate Your Financial Situation
Make sure that your credit score, overall income, DTI ratio, and total debt burden are good. Your total monthly debts must be no more than 43% of your gross monthly income. And if you owe too much money or your DTI ratio is too high, pay down some of your loans first before refinancing.
Step #3: Gather Your Documents
If you took out a second mortgage from a company that is different from your first mortgage, you will need to present documentation from both lenders. You should also prepare documents that show proof of income such as W-2s, pay stubs, and previous tax returns as well as proof of certain assets.
Step #4: Calculate Your Home’s Remaining Equity
If you ever default on your loans and your property gets foreclosed, the debt with your primary loan would be satisfied first. If there are not enough funds to pay off your second mortgage, then the lender simply takes a loss. Because of this, second-mortgage lenders will require you to have enough equity in your home–at least 20%–so that they are not taking on too much risk.
Step #5: Talk to Your Second Mortgage Lender
See if your current lender is willing to refinance the loan and ask them what they need from you to process it. You might get the best refinance terms from them since you are already a customer and they would not want to lose your account.
Step #6: Look for Other Lenders
Even if you already like the refinance rate that your existing lender is offering, it would be good to shop around in case you get better rates from other lenders. After researching and evaluating other offers, you can make an informed decision on where you can save the most money.
Step #7: Apply for Your Refinance
Once you have chosen the lender you will go with, it is time to submit your application. But because reviewing and finalizing your application may take a while, you still need to make payments on your existing second mortgage while waiting for your new loan.
Taking out a second mortgage will help you fund your renovation project or your next investment property purchase. There are three types of second mortgages that you can avail of: the home equity loan, home equity line of credit or HELOC, and piggyback loan. Determining what type of second mortgage to get depends on your needs.
As for refinancing second mortgages, it is possible to do so, but be aware of its pros and cons. Doing this can lower and simplify your monthly payment and lock in a fixed interest rate. But refinancing can also incur more fees, temporarily impact your credit score, and increase your risk of losing your property.
If you are thinking about whether to refinance your second mortgage, you must determine if it is right for you based on your needs and financial situation. Should you proceed, gather your documents and talk to your lender (and other lenders) to try and get the best loan rates possible. Finally, submit your application. But make sure that you stay on top of your monthly payments for your existing mortgages while waiting for the new loan to be approved.
Congratulations, you now have additional funding for your real estate empire! If you are planning to use it to buy a new house, click here to start looking for and analyzing the best investment properties in the city and neighborhood of your choice.
To get access to our real estate investment tools, click here to sign up for a 7-day free trial of Mashvisor today, followed by 15% off for life.