Can I Refinance My Second Mortgage?

Thousands of homeowners across the county have used a second mortgage to help purchase a home. A second mortgage reduces the amount of cash needed for a down payment and can help a homebuyer avoid mortgage insurance. But second mortgages are not just limited to purchases.

With interest rates falling from their post-COVID highs, many homeowners are asking if they can refinance their second mortgage. And the answer is yes, you can.

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What is a second mortgage refinance?

A second mortgage refinance is different from first mortgage refinance. A 2nd mortgage refinance only impacts the second mortgage — it does not affect your first mortgage. You can change your 2nd mortgage’s interest rate and term or it can be a cash-out refinance where you get additional money from the loan post-closing.

Second mortgage refinance benefits

Deciding to refinance your current home equity loan has significant financial implications. Here are five benefits a homeowner might see from refinancing a second mortgage.

1. Shorter term
2. Fixed-rate
3. Lower interest rate
4. Additional cash funds
5. Lower monthly mortgage payment

A new home equity loan to replace your current home equity loan should provide the homeowner with at least one of these five benefits.

Usually, a homeowner’s primary motivating factors are a lower interest rate and monthly mortgage payment. A cash-out refinance is another primary motivating factor.

Rate and term refinance have a lower rate and fewer closing costs compared to cash-out refinances.

Second mortgage refinance requirements

Mortgage lenders offering second mortgage refinance options have specific requirements borrowers must meet before they can be approved by underwriting. Here is a list of the industry standard home equity refinance requirements. There are possible exceptions to these requirements, and I will cover those in detail.

• One to four units (residential property only)
• Primary, secondary, or investment
• 640 or higher credit score
• No first or second mortgage late payments in the last twenty-four months
• Combined loan-to-value ratio of 90% or lower
• Debt-to-income ratio at or below 50%
• High second mortgage refinance loan amounts might require the borrower to have cash reserves with some lenders

One to four units – residential property

Anything above four units will be considered a commercial-type property and would not be eligible for a home equity refinance.

Most lenders require the property to be a primary residence; however, you can find lenders offering a second mortgage refinance product on a secondary home or investment property.

Credit score requirement

Some exceptions can be found for the credit score requirement, but most mortgage lenders want a borrower to have a good credit score. Some lenders will go below a 640 credit score however, that differs from the industry norm. Consider taking immediate steps to improve your credit score if it’s dropping close to 660.

Payment history

When it comes to a borrower’s payment history, lenders want to see you’ve paid all the payments on your current mortgages on time. If you have had a late mortgage payment in the last twenty-four months, you’ll need a good explanation, prove it was a one-off situation, and have strong compensating factors.

Compensating factors are areas of your loan application that are significantly stronger than what is required. For example, if the underwriting requirements are for the borrower to have two months of cash reserves and you have six to twelve, that’s a compensating factor.

You can read our article to learn more about how you can refinance with late mortgage payments.

Combined loan-to-value ratio

A key guideline every borrower must adhere to when getting a new second mortgage is the lender’s combined loan-to-value ratio requirement. What is a combined loan-to-value (LTV) ratio?

A combined LTV ratio is a measurement used by lenders to determine how much a borrower will owe compared to the value of the property being used as collateral. When calculating the combined loan-to-value (CLTV) ratio, an underwriter combines both your first and second mortgage to come up with the CLTV ratio.

CLTV calculation

Here is how you calculate a CLTV ratio for your first and second mortgage.

Total Amount Owed / Property Value x 100 = CLTV Ratio 

If a borrower owns a home worth $800,000 and has a first mortgage of $300,000 and a second mortgage of $200,000, then his CLTV ratio is 62.50%.

300,000 + 200,000 / 800,0000 x 100 = 62.50%

The ideal CLTV ratio for a borrower is 90% or lower. Once you cross the 90% level, you’ll see a significant jump in the interest rates quoted and the fees you’ll have to pay. 

Debt-to-income ratio

A debt-to-income ratio compares your total debts and the income you earn. Every lender uses a debt-to-income (DTI) ratio to determine if a borrower can repay the proposed second mortgage refinance. Lower your DTI ratio to improve credit scores and gain access to more loan options in the future.

Your debt payments include the following

Credit cards, personal loans, car loan payments, and back tax payment plans are included. Your total mortgage payment is also included. Your total mortgage payment is the monthly amount you pay toward the loan balance (principal and interest), property taxes, and property interest. This is commonly referred to as PITI.

When getting a new loan, you have to include your HOA payment in the calculation for those with an HOA.

Do they use gross or net income when calculating DTI?

That depends on whether you are a W-2 employee, self-employed, or retired. If you are a W-2 employee, the underwriter will use your gross income. If you are self-employed, the underwriter will use the net income the business generates and/or pays you directly.

The underwriter uses your gross retirement income from all sources if you are retired.

Calculating your DTI ratio

Here is how you can calculate your DTI ratio for home equity loans. 

(total monthly debt payments / monthly income) x 100 = DTI Ratio

If your monthly debt payments total $4,000, your monthly income is $10,000, and your DTI ratio is 40%. 4,000 divided by 10,000 times 100 = 40%.

Some lenders will go above a 40% DTI ratio on a new loan; however, the ideal DTI ratio for most lenders when approving a second mortgage refinance is at or below 40%.

Cash reserves for high loan amounts

Some second mortgages with a loan amount above $100,000 might require cash reserves. Or loans where it’s a cash-out refinance.

Cash reserves are the amount you have saved in a checking, savings, or liquid investment account that can cover your existing loan and new loan payments. You’ll have to provide two months of statements to the underwriter showing the amount the underwriter is requesting.

Seven steps to refinancing your second mortgage

There is a seven-step process to refinancing into a new fixed-rate second mortgage.

1. Review your current financial situation

The first step is to determine if refinancing makes sense. Review your current home equity loan. Pull up your closing statement and confirm the amount of fees you paid, the number of years remaining on the loan, and the interest rate being charged.

You’ll also want to look at your primary mortgage loan (aka your first mortgage). Review the fees you paid to obtain your primary mortgage loan, the number of years remaining, and the interest rate you are paying to your mortgage lender. Also, you’ll primary mortgage balance.

If you are unsure of your credit history, take a look at that as well.

2. Get your second mortgage refinancing quotes

Once you have reviewed your current situation, it is time for the second step: getting your second mortgage loan quotes. You’ll want to obtain two to three quotes from mortgage companies with a stellar reputation.

Better yet, use House Numbers and they’ll do the research for you. After gathering your details, like how much money you want to access, they’ll shop the market on your behalf to find you the best offer possible. The process takes less than 3 minutes and can be done from the comfort of your home. As a licensed mortgage broker, House Numbers can work with any lender in your area.

3. Determine if a refinance of your second mortgage makes sense

You have your current financial information and quotes from reputable second mortgage lenders, and now it’s time to determine if a refinance of your home equity loan makes sense. The best way to do this is to create a pros and cons list specific to your situation.

Another consideration is to talk with your trusted financial advisor and tax professional.

4. Gather your documentation

You found a great second mortgage lender, you can afford the new monthly payment, and you’ve made the decision to obtain a new second mortgage loan; the next step is to gather your documentation. 

W-2 employee

If you are a W-2 employee, you’ll want to gather your two most recent paystubs and your two most recent W-2 forms. You’ll want to gather this documentation for each employer if you have more than one employer.

If you have a side gig like DoorDash and plan on using that income, you must also gather your most recent two years of tax returns.

Self-employed 

If you are self-employed and looking to refinance your second mortgage, you’ll need to gather the last two years of your tax returns, personal and business. You’ll also need a year-to-date profit and loss statement.

If it’s after the first of the year and before you filed your previous year’s returns, you’ll need to provide a prior year’s profit and loss statement, your current year’s profit and loss statement, and your most recent two tax returns. 

Retired

Borrowers who are retired and considering a second mortgage refinance will need to provide documentation showing their income will continue for at least the next three years. 

If you receive social security or pension income, you’ll be asked to provide your most recent benefits statement, which is generally sent out towards the end of the prior year, along with two months of bank statements showing the income being deposited.

If you receive retirement income from investments, you will need to show that income can continue for at least three years. You’ll need to provide asset statements for the most recent two months, showing you have the investments to provide this income for at least three years.

For example, if you are receiving $5,000 per month from your retirement accounts, you’ll need to show you have at least $180,000 in investments to support that level of income for the next three years.

Documenting investment income

Documenting investment income also requires the borrower to show a history of receiving that income, which generally requires two years of tax returns. So, if you are retired and have yet to file a tax return for your investment income, you might not be able to complete a second mortgage refinance.

The best thing to do is check with the loan officer to see if there are any potential solutions.

Primary mortgage statement and insurance declaration page

You’ll also need to locate a primary mortgage statement and insurance declarations page. If you can’t find a primary mortgage statement, you’ll want to contact the lender to have a new one sent to you or locate the note for your primary mortgage (it’s in the loan documents you signed).

5. Apply with your chosen lender

Applying with your chosen lender can be done online, over the phone, or in person. Usually, the application takes fifteen to thirty minutes to complete. Here is some of the information you’ll need for the application.

• Personal information such as your name, date of birth, and social security number
• Address of the property
• Employment (or self-employed) information, such as the employer’s name, address, phone number, job title, and the number of years employed. If it’s less than two years, you’ll also need your previous employer’s information.
• If your loan officer communicated that you might need cash reserves to qualify, you’ll need your account information (name of institution, account number, and current balance).
• If applicable, a list of all the properties you own. Address, value, the amount owed, rent received, and the taxes and insurance amounts.

Having this information ready to go before you apply will save you time and make the process much more efficient. Information such as who your primary mortgage lender is with is provided on your credit report.

6. Underwritten approval

The underwriting process for a new home equity loan is similar to that of a primary mortgage. Once you’ve turned in your documentation and completed your loan application, the loan officer will review the file to ensure everything is included for the underwriter to review to avoid denial. If your file is complete, the loan officer will then submit the file to underwriting. 

With most lenders who allow you to refinance a second mortgage, an underwriter will review the file within five to ten business days unless there is an unusually high level of files being submitted.

After the underwriter has reviewed the file, they will issue a conditional approval. This means the borrower is approved; however, certain information and/or documents need to be provided before closing.

7. Satisfy your conditions for closing

When your loan officer provides you with the list of items needed for closing, make sure you turn them in within twenty-four to seventy-two hours. Turn in exactly what is being asked, and ensure the documentation is complete.

Ask your loan officer for clarification if you have any questions about what is being requested.

Sign your second mortgage refinance loan documents

After you have turned in the requested documentation, your underwriter will review the file again to ensure you have satisfied all the conditions for closing. If you have, the underwriter will release your file for closing, and it will then head to the lender’s closing department.

The lender’s closing department will then issue loan documents to your closing agent for you to sign your loan documents. Once you’ve signed your loan documents, you can expect your second mortgage refinance to close within a week (usually sooner).

Last word on a second mortgage refinance

Mortgage loans such as a second mortgage refinance loan provide numerous benefits for the homeowner. A lower interest rate and a lower monthly payment are two of the most common benefits a homeowner will see if they refinance their current home equity loan.

Another benefit might be obtaining cash out. Refinancing your second mortgage helps a homeowner avoid a cash-out refinance on the first mortgage (which may have a below-current market interest rate). As with any other mortgage loan program, review the underwriting requirements with your trusted loan officer before applying.

Disclaimer: The above is provided for informational purposes only and should not be considered tax, savings, financial, or legal advice. All information shown here is for illustrative purpose only and the author is not making a recommendation of any particular product over another. All views and opinions expressed in this post belong to the author.