If you’re thinking about getting a home loan or tapping into your home equity for cash, you may have come across options to either refinance or get a second mortgage. Many homeowners are confused by the difference between a refinance and second mortgage so in this piece, we will explain. The difference is simple: with a mortgage refinance, the homeowner replaces their primary mortgage with a new loan, whereas with a second mortgage, the homeowner takes out a new loan without impacting the terms of their existing home loan.
The best choice for you will depend on your goals and what you can get approved for. Read on as we’ll go through the differences between a refinance and a second mortgage, and which one might be the best choice for you.
Quick Comparison
| Refinance | Second mortgage | |
|---|---|---|
| Qualification requirements | Strict | Can be more flexible |
| Amount of documents needed | Can require a significant amount of paperwork | Typically less than a refinance |
| Loan term | Up to 30 years | Up to 30 years |
| Maximum loan-to-value ratio | Typically 95% | Usually 80% or below |
| Minimum Credit Score | 620 | 660, but can vary |
| Speed of approval and funding | Usually 4 to 8 weeks | Usually 2 to 6 weeks |
| Types of loans available | • Rate and term refinance • Cash-out refinance | • Home equity loan • Home equity line of credit |
| Ability to change rate/term on 1st mortgage | Yes | No |
| Ability to get cash for other purposes | Yes, cash-out refinance only | Yes |
| Flexible revolving line of credit | No | Yes, HELOC only |
Are there different types of refinancing?
With a refinance, you can choose between a cash-out refinance or a rate-and-term refinance. Each is nearly identical in terms of the application process, documentation requirements, and funding speed. Approval requirements may vary slightly and tend to be more strict for cash-out refinances.
Cash-out refinance
In addition to replacing your existing mortgage with a new loan amount or interest rate, a cash-out refinance also allows you to get additional cash that you can use as you see fit. Common uses include home improvements, funding college tuition, or consolidating debt.
With a cash-out refinance, your new loan amount is greater than your existing mortgage. Funds are used to pay off the existing loan balance, after which any net proceeds are disbursed to you.
For example, if you have an existing mortgage balance of $50,000, a cash-out refinance of $150,000 would result in $100,000 being deposited to your bank account after the refinance is completed, assuming there are no closing costs to be paid.
Rate and term refinance
With a rate-and-term refinance, the balance of the new loan is used to pay off your current mortgage loan. The main goal of this type of refinance is to modify only your interest rate and/or loan term.
Your new loan balance will be virtually identical to that of your old loan, although it may vary slightly depending on whether you wanted to pay for closing costs out of your own pocket, or include it with the new loan.
Rate-and-term refinance loans are useful if you want to lower your interest rate. Another benefit of this type of refinance is the ability to change the loan term. You can choose a longer term to help lower your monthly payments, or choose a shorter term to pay off your home more quickly.
Are there different types of second mortgages?
The two most common types of second mortgages are a home equity loan (HE loan) and a home equity line of credit (HELOC). With either of these, the terms of your existing first mortgage loan remain unchanged. Rather, you are simply obtaining an additional loan and must make two separate housing payments.
Home equity loan
Home equity loans give you a lump sum of cash at once. Many folks use it in a similar manner as a cash-out refinance, funding home improvements, paying off higher interest rate debt, or funding college tuition for their family. Since a home equity loan does not impact the terms of your first mortgage, it’s a good choice to consider if you know exactly how much cash you need and want to keep the terms of your existing home loan.
Home equity line of credit (HELOC)
A HELOC is a revolving line of credit that allows you to access funds on an as-needed basis. Your maximum credit limit will be determined by your lender. A HELOC is a good option to consider if you have a recurring need for additional funds and don’t want to constantly have to apply for a new loan. It can also be a useful source of funding to cover emergencies or unexpected expenses.
What are the differences between a refinance and a second mortgage?
While similar, a refinance and a second mortgage have a number of differences. This includes the qualification requirements, documents needed to get a loan, loan terms, and speed of approval and funding.
Qualification requirements
In many ways, a refinance typically has more difficult qualification requirements. There is also less flexibility. This is because many mortgage loans are insured by government agencies such as the Federal Housing Administration (FHA). Lenders may also sell the servicing of their loans and be required to adhere to investor requirements, including those from Fannie Mae and Freddie Mac.
Second mortgages, however, are typically held in-house by a lender. As a result, a lender has more flexibility in dictating its own requirements. This results in a greater likelihood that policy exceptions can be issued on loans that may not meet standard guidelines but have sufficient compensating factors to offset any increased risk.
Amount and type of documentation needed
Going with a refinance instead of a second mortgage generally means more documentation requirements, and this is partially due to the fact that lenders must ensure the loans adhere to investor and government program requirements. Second mortgages, on the other hand, often have fewer documentation requirements.
Below is a list of items that may apply to both second mortgages and refinances:
- Appraisal of your home: Many refinances require a full interior and exterior appraisal inspection. A second mortgage, on the other hand, may only require an exterior drive-by appraisal (read about appraisals for home equity loans). In some cases, a computerized estimate of your home’s value is sufficient for a second mortgage.
- Income documents: Income documents can include tax returns, pay stubs, and W2s. Self-employed borrowers may also have to provide balance sheets and profit and loss statements.
- Credit: Credit-related items can include newly obtained debt or explanations for discrepancies such as payment amounts not being reported on your credit report. On a refinance, lenders are typically more strict on the required paperwork and may only accept formal documents such as a loan statement or a promissory note. With a second mortgage, however, lenders are more likely to accept less formal paperwork such as email printouts or bank statements showing withdrawals made for a loan.
- Assets: Asset-related items can include bank statements or paperwork to support unusual deposits in your checking or savings accounts. Just like credit-related items, lenders on a refinance are more likely to be strict on acceptable paperwork.
Loan terms such as rates and fees
Rates and fees will vary between a refinance and a second mortgage. There are many types of loans, but here are the key aspects you should consider:
- Interest rate: You’ll usually get a higher interest rate on a second mortgage. This is largely due to the fact that lenders issuing a second mortgage stand to lose more if you default on your payments.
- Closing costs: Fees are usually higher on a refinance than on a second mortgage.
- Loan term: Both refinances and second mortgages are similar in the sense that both can have long repayment terms of up to 30 years.
- Fixed vs. variable interest rate: With a refinance, you can choose between an adjustable-rate mortgage or a fixed-rate mortgage. On a second mortgage, most home equity loans come at a fixed interest rate, while HELOCs typically have a variable interest rate.
Speed of approval and funding
It will usually take longer to get a refinance compared to a second mortgage. On average, refinances can take between four and eight weeks to complete. A second mortgage, however, usually takes between two and six weeks to complete (read more on how long a HELOC takes to close) .
This is largely due to the fact that it takes more time for lenders to not only review the paperwork on a refinance but also to ensure that the proper due diligence is completed. Since second mortgages typically have less paperwork and a greater level of flexibility with regard to what is considered acceptable and adequate, the loans tend to get approved and funded more quickly than a refinance.
What are the similarities between a refinance and a second mortgage?
Many folks considering a second mortgage also consider a cash-out refinance because the loan proceeds can be used in a nearly identical manner. In other words, there are usually no differences in how you are allowed to use funding that you get from either a refinance or a second mortgage.
Common uses for a second mortgage and cash-out refinance include:
- Home improvements
- College tuition
- Vacations
- Home repairs
- Debt consolidation
- Car repairs
- Furniture and appliances
When might a refinance be a better choice?
A refinance, whether it is a rate and term or cash-out refinance, could be a better choice if it falls into any of the following scenarios:
- You can lower your interest rate: If you’re able to get a lower interest rate on your first mortgage, you could lower your monthly payments, save on interest fees, and pay off your mortgage more quickly. Since mortgages carry fees and other closing costs, it’s important that you can recoup the costs of refinancing in a reasonable amount of time.
- You don’t want to have 2 separate housing payments: Since a refinance essentially replaces your existing housing payment, this can help keep your finances and monthly budget simple. To further simplify things, you can also have the option of including your annual property tax and homeowner’s insurance payments with your monthly mortgage payment. This is often referred to as impounding or escrowing taxes and insurance.
- You want to lower your monthly mortgage payment: In addition to being able to get a lower interest rate, you can also change the length of your loan. By choosing a longer loan term, your monthly payments will be spread out over a longer period of time. Although you might be able to save money each month, you may end up paying more interest charges over the life of the loan.
You want to pay off your mortgage more quickly: Paying off your mortgage more quickly can be done by lowering your interest rate. It can also be done by shortening the length of your loan. With a shorter loan term, you’re more likely to get a lower interest rate, and a higher portion of your monthly payments will be allocated toward the principal portion of your loan rather than toward interest fees. You’ll end up with higher monthly payments overall, but you’ll save money over the life of the loan and end up with a paid-off home more quickly.
When might a second mortgage be a better choice?
A second mortgage, such as a HE loan or a HELOC might be a better fit for you if you fall into any of the following scenarios:
- You just want a source of funding to cover emergencies: A HELOC can be used to get quick access to cash in an emergency. It can help cover things like home repairs, fixing or replacing appliances, car repairs, and more. However, it’s a good idea to check your loan’s fee schedule. Some HELOCs charge fees if not used within a certain time frame.
- You have a recurring need for funding: A HELOC can be a good choice if you see a recurring need to get additional funding and want to avoid having to frequently reapply for a new loan. One example is obtaining debt that you expect to be paid off within a short time frame, which might be the case with college tuition and tuition reimbursements.
- You don’t meet the qualification requirements for a refinance: Since second mortgages tend to have more lenient guidelines, it’s possible that you could get funding with this type of loan even if you were denied a refinance.
- You want to keep the loan terms on your first mortgage: If you don’t want to change the terms of your first mortgage loan, then you can consider getting a second mortgage instead. This might be the case if refinancing would result in an excessive amount of fees, or if you already have a low interest rate on your first mortgage.
- You have enough equity in your home: Home equity loans usually require you to have at least 20% or more equity in your home. To calculate your home equity, you’ll need to figure out what similar homes in your area have recently sold for, and then subtract the balance of the mortgage loans against the property.
Difference Between Refinance and Second Mortgage
A refinance, whether it is a cash-out refinance or a rate-and-term refinance, is a good choice if you want to replace your existing mortgage with a new rate, loan term, or tap into your home equity to get cash. On the other hand, a second mortgage such as a home equity loan or HELOC could be a better choice if you don’t want to change any of the terms on your existing first mortgage. There are also differences in qualification requirements and the length of time required, so the best choice will depend on your circumstances and goals.
