Did you know you can use the equity you built in your home? You do this by tapping into it with a second mortgage, and you don’t have to sell your home to access the funds.
A second mortgage can be a home equity loan or a line of credit. A home equity loan has a fixed interest rate and provides the funds in one lump sum. A line of credit has a variable interest rate, and you can draw on your credit line as needed.
Sometimes, though, you need to refinance your second mortgage. Here’s how it works.
Reasons to Use a Second Mortgage
There are many reasons you might consider borrowing a second mortgage. However, here are the most common reasons borrowers use one.
Buy a Home
If you want to avoid Private Mortgage Insurance, you can use a second mortgage as a form of the down payment on the home. For example, if you borrow 10% of the home’s value with a second mortgage, put 10% down yourself, and borrow 80% with the first mortgage, you avoid PMI and keep your mortgage payments low.
Have a Line of Credit
Some borrowers tap into their home equity with a HELOC (home equity line of credit). A HELOC is a line of credit on your home; it works like a credit card. You can leave the funds untouched and not owe any interest, or you can draw the funds, use them how you want, and pay interest only on the amount you withdrew.
Pay off Debt, Pay a Large Expense, or Renovate your Home
Another way to borrow money from your home is a home equity loan. This loan isn’t a line of credit. Instead, you receive all funds in one lump sum and only one time. You can use the funds however you need and have a fixed-rate loan with monthly principal and interest payments.
Steps to Refinance a Second Mortgage
If you already have a second mortgage, you might wonder how you can refinance it. Some borrowers want to refinance for a fixed-rate loan versus an adjustable-rate HELOC. Others want to tap into more equity or don’t like their loan terms.
There are a couple of ways to refinance a second mortgage.
Cash-Out Refinance
If you have at least 20% equity in your home, you can use a cash-out refinance to consolidate your home equity loan or HELOC with your primary mortgage.
Borrowers choose this option to get more competitive interest rates and to consolidate their payments into one loan. A cash-out refinance can be a conventional, FHA, or VA loan, but you must have at least 20% equity untouched in the home to qualify.
Refinance your HELOC into a Home Equity Loan
Some borrowers prefer to turn their HELOC into a home equity loan. This is common when borrowers have a competitive rate on their first mortgage and don’t want to lose it, but they want a fixed rate on their second mortgage.
HELOCs have a variable interest rate that can be adjusted monthly. However, the unpredictability of the payment and amount of interest owed can make it hard to budget, so refinancing into a fixed-rate home equity loan can be desirable.
Before choosing this option, ensure you understand that you won’t have a credit line to draw on any longer as you lose the revolving part of the loan.
How to Qualify for a Second Mortgage
Qualifying for a second mortgage is similar to qualifying for the first mortgage. However, second mortgage lenders take more risk than first mortgage lenders, so some may have tighter restrictions.
In general, lenders require:
- Good credit – Try to have a credit score of 660 or higher to increase your chances of securing a second mortgage. Because lenders take a second lien position, they aren’t paid first if you default on your loan, so they like borrowers with higher credit scores.
- Average debt-to-income ratios – Your DTI measures your current debt to your monthly income. The lower your DTI is, the less risk you are of defaulting on your second mortgage. Keep your ‘other debts’ low to ensure you get approved for a second mortgage.
- Stable income and employment – Lenders like borrowers with a 2-year+ employment history to prove you are a good risk. They prefer borrowers who stay with the same employer/job versus those who change jobs frequently.
- Enough equity – You’ll need at least 20% equity in the home that you can leave untouched to qualify for a second mortgage. This is the lender’s ‘insurance policy’ should they need to foreclose on your property.
How much can you Borrow?
The amount you can borrow on a second mortgage depends on your qualifying factors. Most importantly, lenders look at your home’s equity. Most people can borrow up to 80% of their home’s value, including the outstanding balance on their first mortgage.
For example, if your home is worth $300,000 and you have a first mortgage with a $150,000 balance, you can borrow an additional $90,000, leaving 20% equity in your home.
However, you aren’t entitled to borrow the full amount unless you qualify. You must prove you can afford the payments by proving your income and current debts to ensure the second mortgage payment fits into your income and doesn’t make your DTI higher than allowed.
Final Thoughts
It’s a little tougher to refinance a second mortgage, but there are ways. Before refinancing your second mortgage, determine why you want to refinance it.
If you’re looking to get a fixed payment and don’t need the line of credit any longer, compare your options between a cash-out refinance of your first mortgage to combine the two and a standalone second mortgage.
Look at the loan’s total cost and compare the monthly payments to determine which is most effective. If you need help determining your options or qualifying to refinance your second mortgage, contact us today!
