There may be many reasons as to why someone might refinance a mortgage. While most homeowners are aware you can refinance a mortgage before it is paid in full, not many know it is possible to refinance a first or second mortgage. Refinancing second mortgages are pretty similar to how you would refinance a first mortgage. It can create a new loan, smaller monthly payments, or lower interest rates. This article will explore the technicalities behind refinancing second mortgages.
What is a Second Mortgage?
A second mortgage is an additional mortgage other than the primary mortgage loan on a property. There are a few different types of second mortgages someone might take out on a property. The first type of second mortgage is a home equity loan. This loan is pretty similar to your primary or first mortgage but the amount of money you can borrow depends solely on the equity of your home. You may be thinking what is equity? Equity is the amount of money that is the difference between what your home is worth, and what you owe on your mortgage. Therefore, to get a home equity loan as your second mortgage, you would first need to calculate your property’s equity before you know how much money you are eligible for.
Once the equity of your home is calculated you are able to take out a home equity loan, or second mortgage loan, on that calculated equity. Typically, if you are approved, you will receive that money in a lump sum. It will be required you set up a payment plan to pay the loan back, most commonly in monthly installments with interest, similar to how you would pay your first mortgage.
Unlike other types of loans such as student loans or auto loans, you are able to use this money from the second mortgage loan for anything. Second mortgage loans also typically have lower interest rates. This makes them appealing for individuals to use the money from the second mortgage to pay off credit card debt or use the money towards home improvements. If you also use the money for home improvements, you can then write off the interest you pay on income taxes, as this improvement will increase the value of your home.
Another type of second mortgage is a HELOC, or a home equity line of credit. Like a home equity loan, the amount of money you are able to get from a home equity line of credit also depends on the equity of your home. The difference is a HELOC is more so like a credit card. You have a maximum credit limit that is determined by the equity of your home. In a HELOC, you only have to pay back what you borrowed. For example, if you take out a HELOC with a credit limit of $80,000 but you only end up spending $20,000 on that line of credit, you only need to pay back the $20,000. Similar to most other loans, you will pay whatever you spent on the line of credit back with monthly payments and interest.
The last type of second mortgage is a piggyback mortgage. An individual would take out a piggyback mortgage to avoid paying PMI, or private mortgage insurance. A PMI is an insurance that protects lenders who are giving out money for loans. The only downside of this protection is it can add hundreds of dollars to your mortgage payments every month. A piggyback loan can also be referred to as an 80-10-10 loan because borrowers can cover 80% of a properties loan with a primary loan or first loan, then they cover the next 10% with a second mortgage loan, and the last 10% is paid with their down payment of the property.
What are the Pros of a Second Mortgage?
Like any type of loan or mortgage, there are benefits that draw homeowners and real estate investors to do such. Below are some of the benefits of a second mortgage:
- They have low-interest rates: Second mortgages typically have much lower interest rates than most credit cards. Unlike credit cards, second mortgages are considered a type of secured debt. This means they have your property as collateral behind them. These lower interest rates are offered by lenders because they have less risk than credit cards. It is less likely the lender will lose money in this transaction, so lower interest can be offered.
- There are little to no limits on how the funds are used: You are able to use the money received from your second mortgage in any way you may like. There are no guidelines or requirements on how this money should be spent. If you are a real estate investor, this money can even be put towards a new investment property. To start looking for and analyzing the best investment properties in your city and neighborhood of choice, click here.
- They can have higher loan amounts: Similar to how there are lower interest rates on second mortgages, they can also be significantly higher than other loans. Most lenders offer up to 90% of the equity of your home in a second mortgage. As there is less risk for them as they have your property as collateral, they can offer more money for these loans. Lenders will especially offer higher amounts of money if you have made any payments on your current loan for a long period of time.
What are the Cons of a Second Mortgage?
Even though there are many benefits of a second mortgage, there are some cons you should be aware of too before applying to this loan:
- They might add pressure to your budget: In some cases, when you take out a second mortgage you add an additional monthly payment to your budget. This means you will be paying one mortgage payment to your primary lender and another payment to your second mortgage lender. This could negatively impact your debt to income ratio, as this second monthly payment could be doing more harm than good. You can also look into refinancing second mortgages to help alleviate some of this pressure on your budget.
- In some cases, they can have higher interest rates: Although second mortgages typically have lower interest rates than credit cards, they sometimes don’t have lower interest rates than refinances. This is due to the fact primary lenders have more interest in your home than secondary lenders might have.
Can you Refinance a Second Mortgage?
The short answer is, yes it is possible to refinance a second mortgage. It is also possible to refinance both your primary and second mortgage. The types of second mortgages you can refinance include home equity loans, HELOCs, and piggybank loans. This is an ideal option for some homeowners owners and real estate investors as it can combine two mortgages into one. This would mean you would only have one monthly payment rather than two separate payments on your primary and second mortgages. Additionally, it is possible this new combined mortgage payment could be less money paid towards your mortgage each month if the interest is low enough. This would save you money each month to put towards other things.
One of the biggest challenges to refinancing your second mortgage is in home equity. On average, lenders require borrowers to have at least 20% of the equity in their homes in order to refinance their second mortgage. It sometimes can be difficult for borrowers to reach that percentage in equity even though they are already refinancing two mortgages.
If you are not looking to combine two mortgages into one, you can stick to only refinancing second mortgages. One may want to only refinance a second mortgage to change that specific mortgage’s interest rate to an adjustable one. This would make it easier every month to keep up with your payments. Second mortgages such as HELOCs and home equity loans are able to be refinanced to an adjustable interest rate.
Can you Refinance Both a Primary Mortgage and a Second Mortgage?
It is possible to refinance a primary mortgage even if you have a second mortgage taken out on a property. The only catch is having a second mortgage makes refinancing your primary mortgage a little more difficult.
The first way you can refinance a primary mortgage while having a second mortgage is if your lender of the second loan agrees to resubordination. This means that after you refinance your primary mortgage, the lender of the second mortgage agrees to stay in the subordinate position. They need to agree to this because typically after your primary loan is refinanced, your second mortgage becomes your first as it is the older debt. You will have to request your lender stays in the subordinate position after your primary loan is refinanced. A homeowner or investor may choose to request this because they like having a second mortgage. This second mortgage may offer a flexible line of credit that can be used for any purpose.
Another way you can refinance a primary loan while having a second mortgage is by combining the two mortgages into one loan. If you even want to think about refinancing second mortgages and primary mortgages, you need to have at least 20% equity in your home or property. If you don’t have at least that equity, this way of refinancing a primary loan isn’t an option.
What are the Pros of Refinancing a Second Mortgage?
- They can eliminate an adjustable-rate mortgage: Refinancing a second mortgage can let you change your loan into a fixed-rate loan from an adjustable-rate one. Sometimes, a loan can vary depending on the performance of economic indexes, which can then change your mortgage payment. Refinancing second mortgages allows you to control this factor.
- They can lower your monthly loan payments: Most people who choose to refinance a second mortgage do so to lower their monthly payments. Refinancing second mortgages creates lower interest rates, which therefore makes your monthly payments lower. Additionally, if you combine your primary and second mortgage you will only have to make one payment a month rather than two, which has only one interest rate on it as well. Overall, refinancing second mortgages helps to create lower monthly loan payments.
What are the Cons of Refinancing a Second Mortgage?
- It is essential you never miss a monthly payment: If you choose to refinance a second mortgage you have to make sure you are continuing your monthly payments. Missing a payment can increase your risk of losing your home or property. If you stop making payments, then a lender can take ownership of that property instead, through the foreclosure process.
- Refinancing a second mortgage is not free: Depending on the lender, it is expected you would pay between 2%-5% of the loan’s principal balance in the closing costs. You would have to see if it would be possible to lower your interest rates enough in refinancing second mortgages to make up for those costs.
How do I Refinance a Second Mortgage?
The first step of refinancing any type of second mortgage is to find a lender. You can continue using your current lender or find a new licensed lender.
Next, with any lender, you will need to prove your income. You will likely need to provide documents to that lender proving your income and that you are able to keep up with monthly payments. These documents can include bank account statements, tax returns, and W-2 forms. You will also need to provide the lender with your credit score. This will prove you have a good history of paying your bills on time.
Lenders will also want to see your debt to income ratio. Basically, the debt-to-income ratio shows the relationship between your income and monthly debts. Lenders will want this debt to be no more than around 40% of your monthly income, although that percentage can vary based on the lender.
Lastly, a loan-to-value ratio is needed for lenders to be able to provide a loan. This shows how much you owe on your current or primary loan.
There are many factors to consider before refinancing a second mortgage but doing so might create benefits for you that outweigh the cons. Visit Mashvisor to learn more about how we will help you make faster and smarter real estate investment decisions.