Refinancing a Second Mortgage
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If you have a second mortgage on your home, there may come a time when refinancing that loan starts to look like a good idea. Whether you’ve entered the repayment period on a home equity line of credit, or you’ve noticed that interest rates have dropped, refinancing may save you money on your monthly payment or over the life of the loan. If you want to refinance your second mortgage, there are a few things you’ll need to know first.
What is a second mortgage?
When you purchase a home, the initial loan is your first mortgage. For many buyers, this will be the only loan they ever take out related to that property. But some circumstances may necessitate a second loan. In the simplest terms, a second mortgage is a second loan that uses your home as collateral.
There are several different types of second mortgages, including:
Home equity loans: A home equity loan is exactly what it sounds like. The borrower gets a lump-sum loan based on the amount of equity in the home. Most home equity loans have a fixed interest rate, and repayments are part interest, part principal. Like a lot of loans, repayment begins within a specified time (usually a month or two) after you receive the money.
HELOC: A home equity line of credit allows homeowners to take out money based on the amount of equity they have in the property. A home equity line of credit is different from a home equity loan because of how the money is distributed. With a HELOC, the lender allows a withdrawal period (where the borrower can access the funds as needed, a bit like a credit card). During the withdrawal period, borrowers make interest payments based on how much of the total available credit line they’ve used. During the repayment period, borrowers begin to repay the balance of the loan.
Piggyback loans: A piggyback loan allows buyers to purchase a home with less than 20% of a down payment without paying for private mortgage insurance. A typical piggyback loan might break down with the first mortgage funding 80% of the home purchase, the buyer funding 10% and the second loan funding the last 10%. (Piggyback loans are also known as 80-10-10 mortgages.)
Why refinance a second mortgage?
A second mortgage is an alternative to personal loans and credit card debt, both of which can have higher interest rates. And while the risk is higher with a second mortgage (you can lose your home if you don’t keep up with payments), a second mortgage could provide more flexibility, such as the ability to refinance.
There are several reasons a borrower may consider refinancing a second mortgage. Homeowners are more likely to take out a second mortgage to use it for things such as:
Home improvement projects: Spending a second mortgage on the right upgrades could improve the value of a home for resale.
Avoiding taking out a personal loan: Some borrowers opt for a second mortgage to avoid a personal loan and save on higher interest rates. A second mortgage could provide extra cash flow. Ben Smith, a loan officer with Deseret First Credit Union in Murray, Utah, noted that a home equity loan may be cheaper than a personal loan, so it could be a good option for homeowners. “Definitely, second mortgages are cheaper, and the interest rate may be tax deductible,” Smith said.
Note: As of Jan 1. 2018, the interest paid on second mortgages is only tax deductible if you use the money to substantially improve your home.
Medical expenses: A medical emergency can be costly. Some borrowers opt to take out a second mortgage to cover medical expenses and avoid credit card or personal loan debt.
Paying for education: Borrowers could take out a second mortgage to cover educational expenses for themselves or their children. Interest rates can be comparable, so borrowers should do some research before risking their home to pay for education expenses.
Avoiding private mortgage insurance: When a buyer wants to purchase a home without the recommended 20% down payment, they may opt for a piggyback loan, which acts as a second mortgage. This allows them to avoid paying a premium for private mortgage insurance.
Borrowers who use the funds for the above reasons may want to refinance their second mortgage to save money. Refinancing a loan could free up some cash every month or allow you to pay off the debt faster. Borrowers may want to consider refinancing their second mortgage under the following conditions:
Improved credit score: If your credit score has increased substantially since you took out your second mortgage, refinancing could lower your interest rate (and your monthly payment.) This could make the payments more affordable and save you money over the life of the loan.
Interest rates have changed: Interest rates fluctuate, and you may find that the numbers are attractive enough to offer substantial savings. For example, if you have a second mortgage for $100,000 at 5.63%, your payment on a 15-year loan would be around $824. If you could refinance the loan to 4%, your monthly payments would drop to $740. Over 12 months, that’s a savings of about $1,000. Remember to factor in the cost of a refinance (there are fees) to determine if the money saved would be equal to or more than the fee.
You want to change loan terms: Refinancing may be a good idea if you want to fold your second mortgage into your first, change from an adjustable rate to a fixed rate or change repayment terms (i.e., from 30 years to 15 years).
You plan to stay put: Refinancing any mortgage (first or second) may not be a smart move if you plan to move out of your home in the next few years. Any savings you gain from the refinance may not equal the amount of the refinance fee.
You want to sell your home: Alternatively, if you want to sell your home, refinancing your second mortgage into your first could make it easier to sell your home. If getting out of the property is more important than saving a few thousand dollars, this may be a helpful option.
Steps to refinancing a second mortgage
- Determine if refinancing the second mortgage is right for you. While rates vary, it’s not unusual for lenders to charge 3% or more of the total mortgage as the refinance fee (on a $100,000 loan, that’s $3,000). If you don’t have the cash readily available, or the savings you get from your lower interest isn’t equal to or more than the fee, it may not be the right time.
- Find out if you qualify. To qualify for a refinance, your lender may look at your property value. If it doesn’t meet LTV (loan-to-value) ranges, the lender may not approve your refinance. Additionally, lenders may look at your credit score and other financial information to determine your eligibility.
- Get your finances in order. Your lender will look at your credit score and your debt-to-income ratio to determine what type of terms to offer for your refinance. If you have a second mortgage through a separate company than your first mortgage, you’ll need documentation from both. If you are hoping for lower interest rates, keep tabs on your credit score and your credit history since lenders will look at both of these.
- Do your research. Check out interest rates and research different lenders to find out which lenders offer your best terms. Talking with your current lender may be a good first step since it is familiar with your loan, so it can provide insight into options that might work best for your situation. You can search for other lenders on LendingTree.
- Gather any needed paperwork. Save time during the refinancing process by collecting all the necessary paperwork, including financial statements and documents, about your primary and second mortgage. Talk to your lender to see if it has any unique requirements.
- Apply for your refinance. Once you’ve determined the lender with which you want to work, submit your application. Be prepared for a phone call (or two) and requests for more information.
- Keep making payments. Continue to make your payments on your second mortgage before and during the refinance process. Your lender will review your refinance and finalize any paperwork. A refinance uses a new loan to repay your old mortgage. Your adjusted terms take effect with your new loan. Once your lender approves your refinance, you’ll be sent a statement detailing your amount owed, due date, interest rate, etc.
Tips and tricks
Refinancing a second mortgage can be more difficult than refinancing the initial home loan because the lender of a second mortgage carries more risk. (If for some reason you foreclose, the lender of your first mortgage gets paid first.) Your lender may prefer that you refinance both loans into one.
Try fixed rate
Smith recommended going for a fixed-rate second mortgage versus a home equity line of credit. If you have a line of credit, refinancing to a traditional home equity loan may be beneficial. “A HELOC has an adjustable rate, so customers can save money going with a fixed-rate second mortgage instead,” he said.
There are risks with a second mortgage. For example, in most cases, you cannot sell your home when you have a second mortgage on the property. “A risk of getting a second mortgage is that you are using up the equity in your home,” Smith said. Borrowers in this situation may consider refinancing their second mortgage with their first mortgage to consolidate the loans into one.
Refinancing a loan may make it easier to keep up with your monthly payment since a lower interest rate means a lower bill every month. If you are concerned about keeping up with your payments, and you qualify, refinancing could be a simple way to take some pressure off. You may even consider refinancing from a HELOC to a traditional home equity loan to take advantage of the fixed rate.
Under new tax laws, there are some changes concerning whether you can itemize the interest paid on certain mortgage loans, specifically second mortgages. To take advantage of the tax benefits, you must use the funds from a second mortgage to substantially improve the home or property. While the specifics are a little less defined, the work must improve the value of the home, adapt the home for other uses or maintain the property so that it lasts longer. If your second mortgage doesn’t qualify for the tax benefits, refinancing into one mortgage may be more financially beneficial.
If you’re considering refinancing your home equity loan, talk to a lender. It can help you determine if your credit score qualifies you for lower interest rates.