Have you been thinking about trying to save money by refinancing your home equity loan, home equity line of credit (HELOC) or another second mortgage? If interest rates are lower than they were when you first took out your loan, you can save money by lowering your monthly mortgage payment or shortening the loan’s length to reduce the amount you pay in interest.
Before refinancing your second mortgage, it’s important to know your options, what to consider and how to refinance your second mortgage.
What Is a Second Mortgage and How Does It Work?
A second mortgage is a loan you take out in addition to your primary (or first) mortgage.
Note: For the sake of simplicity, we’re going to focus on a second mortgage taken out on your primary residence, not a second home or investment property.
Most homeowners use second mortgages to access their home equity and turn it into cash they can use to renovate their homes or consolidate debt.
Applying for a second mortgage can look a lot like applying for a primary mortgage (the loan that helped you purchase your home). Like a primary mortgage, a second mortgage uses the home as collateral. Homeowners pay back the loan in monthly installments over the loan’s term.
Homeowners commonly use second mortgages and refinance loans to tap into the value of their homes. Sometimes there is confusion over how these two options differ.
When you refinance, you replace an existing loan with a new loan that has entirely new terms and a different interest rate. A second mortgage does not replace a loan. It exists as an additional debt to the first mortgage.
What Are the Different Types of Second Mortgages?
The two most popular second mortgages are home equity loans and home equity lines of credit (HELOCs).
Home equity loan
A home equity loan allows you to borrow against the equity you’ve built up in your home. Most home equity loans require a minimum of 15% – 20% equity in your home. A lender will cap the loan at a maximum combined loan-to-value (CLTV) ratio of 85%. Your CLTV is the total of all loans on your home divided by the current market value of your home.
Here’s what this might look like in a real-world scenario:
Let’s say your home is worth $400,000, and you owe $200,000 on your mortgage. That means your CTLV is 50%. If your lender says you can borrow up to 85% of the home’s value ($340,000) minus what you owe on your mortgage ($200,000), you can borrow up to $140,000.
When you take out a home equity loan, the lender advances a one-time cash payment for the approved loan amount. Like your first mortgage, you’ll pay back the loan in fixed monthly installments over the life of the loan, which can range from 5 to 30 years.
Home equity line of credit (HELOC)
A HELOC is a popular type of second mortgage. Instead of receiving a lump-sum payment, like a home equity loan, you receive a line of credit. HELOCs usually give homeowners 10 years to withdraw money up to the loan’s limit. This period is known as the loan’s draw period.
During the draw period, you can borrow money on an ongoing basis and only pay interest on what you borrow. Many homeowners apply for a HELOC to pay for home improvements, large medical bills or student loan debt.
Once the draw period ends, you enter the repayment period. You pay back the entire loan (plus interest) with monthly installments during the repayment period. The repayment period is typically longer than the draw period. It usually lasts 10 – 20 years.
A piggyback loan is a second mortgage (either a home equity loan or a HELOC) you take out after your first mortgage to help finance your home purchase. With a piggyback loan, you won’t have to bring as much cash when you close on the house, and you can avoid private mortgage insurance (PMI).
Most piggyback loans are 80/10/10 mortgages. The primary mortgage covers 80% of the home price. The second mortgage covers an additional 10% of the home price. And the remaining 10% is your down payment.
Can You Refinance a Primary Mortgage if You Have a Second Mortgage?
Yes, you can refinance a primary mortgage even if you have a second mortgage – but there are some conditions attached.
Let’s say you have a primary mortgage and your second mortgage is a home equity loan. You decide to refinance your primary mortgage instead of your second mortgage because your home equity loan already has a great interest rate. As long as you have enough equity and the lender who issued the home equity loan agrees to remain in the second mortgage position, you can refinance your primary mortgage.
Some homeowners combine and refinance their primary mortgage and second mortgage, consolidating them into a single loan with a single debt, reducing their monthly mortgage payments.
Refinancing your first and second mortgage into one loan can be more complicated than refinancing a primary mortgage while leaving your second mortgage untouched, but it is an option you can discuss with a mortgage professional.
One option for consolidating mortgages is to do a cash-out refinance of your primary mortgage, using the funds to pay off your second mortgage. For a cash-out refi option to work, you’ll need a certain amount of equity in your home. If you can get a lower interest rate on your primary mortgage, you’ll save money on the mortgage rate you would have paid on the second mortgage.
How To Refinance a Second Mortgage in 7 Steps
Refinancing a second mortgage doesn’t have to be complicated. We’ve broken down the refinance process into seven simple steps.
1. Run the numbers to calculate your savings
Run the numbers to determine if refinancing will save you money. A mortgage refinance may not be worthwhile if interest rates have increased since you took out your second mortgage.
Even if interest rates are lower than your current rate, you’ll have to account for closing costs, which can add up to 6% of the loan’s value to your total. The added cost may negate any savings you’d get from refinancing.
2. Check your credit and debt-to-income (DTI) ratio
In many cases, you can refinance a second mortgage. However, eligibility will be based on your credit, DTI and home equity.
Lenders will check your credit and DTI before approving you for a loan, so make sure you meet their loan requirements. Check your credit score and evaluate your finances first. If your credit needs work, you may benefit from taking a few months to increase your score before you apply.
3. Make sure you’re eligible
Lenders require a certain amount of equity in your home and want to check the status of your finances before they qualify you for a refinance. Talk to your lender to determine your eligibility. And while you have your lender on the line, ask them what your refinance options are.
4. Prepare the paperwork
You must remember the stacks of paperwork you submitted when you got your first and second mortgages. Well, refinancing isn’t much different. You’ll need to gather your financial documents, tax returns, insurance policy information and other documentation to refinance your second (or first) mortgage.
5. Complete an application
After speaking to several lenders (we recommend at least three), complete a few applications so you can weigh your options. Like any loan application, applying to refinance your second mortgage will require a hard inquiry, meaning the lender’s credit check will appear on your credit report. But as long as you apply with all your chosen lenders within 14 – 45 days of each other, multiple inquiries will only be recorded as a single inquiry.
6. Review the terms and decide if you want to refinance
Once you’ve been approved, compare loan terms to decide which loan is right for you.
7. Make on-time payments
The final step is to make your payments on time. On-time payments are crucial if you want to maintain a good credit score and – more importantly – avoid losing your home.
What Are the Pros and Cons of Refinancing a Second Mortgage?
Refinancing a second mortgage can save you money by lowering your monthly mortgage payment, but saving money isn’t guaranteed. Let’s compare the pros and cons of refinancing a second mortgage.
When Should You Refinance a Second Mortgage?
The right time to refinance will depend on a lot of personal and economic factors that may steer you in one direction or another. For example, if the interest rate on your second mortgage is higher than current rates – let’s say there is more than a 2% difference – it may be worthwhile to explore refinancing.
As a general rule, if refinancing your second mortgage doesn’t help you save money or build equity faster, it may not be worth the time, effort and money to refinance. Another factor that might discourage you from refinancing is the state of your credit. If you have bad credit or a high DTI, you likely won’t get a loan. And if you can get one, it may not be with favorable loan terms.
If you’re not sure whether to refinance your second mortgage, ask for help. Talk to a mortgage professional whose expertise and experience can help you make a choice you’re comfortable with.
Two’s Company, but You Might Be Better Off With One
Refinancing a second mortgage might be an option – but carefully consider if it will save you money. You may even find there is an opportunity to refinance your first and second mortgage into a single loan.