Second Mortgage vs. Refinance: Which Is Right for You?

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A second mortgage or refinancing your home mortgage could help put you in better financial shape so long as you choose the right one for your goals. 

A second mortgage and refinancing are two of the most common ways homeowners tap into their equity to fund home renovations or pay off high-interest debt. While both offer access to equity, the winner of a second mortgage vs. refinance ultimately boils down to your long-term financial goals. 

“The biggest part is what your current interest rate is on your home and how much money you need access to,” says Jason Lerner, area manager for First Home Mortgage and a 22-year mortgage industry veteran. 

This article examines the differences between a second mortgage and refinancing your mortgage to help you make the best decision for your situation. 

What Is a Second Mortgage?

A second mortgage is a home loan that provides cash by borrowing against a percentage of your home’s equity. You can take out a second mortgage while still repaying your original mortgage, and like the primary mortgage, the second mortgage uses your property as collateral. Home equity loans or a home equity line of credit (HELOC) are common types of second mortgages.

Generally, to apply for a second mortgage, you must meet the following requirements:

• Have at least 15% to 20% equity in the home 
• Have a remaining balance on your current mortgage that’s less than 85% of the home’s value
• Have a credit score of 620 or higher

Types of Second Mortgages

The main types of second mortgages are home equity loans and home equity lines of credit (HELOCs). Here’s a quick description of each and tips on when to consider them. 

Home Equity Loan

A home equity loan is a second mortgage you can use to borrow against the equity in your home. You'll receive a single lump-sum payment. Like your original mortgage, you will repay the loan in monthly installments with interest at a fixed rate. A home equity loan can be a good option if you need a single lump sum, for example, to purchase a second property or pay significant medical expenses. 

Home Equity Line of Credit (HELOC)

A home equity line of credit, or HELOC, is a type of second mortgage that functions differently from a home equity loan. In the case of a HELOC, you will have a line of credit to access when you need it, similar to a credit card.

You'll get continuous access to funds at a variable rate. HELOCs typically have a draw period and a repayment period. The draw period starts when you take out a HELOC, allowing you to spend up to your credit limit without making any principal repayments. You will still have to make interest payments. 

You pay back the remaining balance monthly after the draw period ends. The major risk is that interest rates are variable. If you draw too much, you could face high repayment costs of principal plus interest and risk defaulting on the loan.

Pros

• Get access to funds when you need them with multiple options.
• Choose the amount based on equity so you don't take more than you need.
• Some lenders allow a fixed rate, which can help you budget for repayment of either a HELOC or a home equity loan. 

Cons

• With common variable interest rates, especially on HELOCs, you risk taking out more than you can comfortably repay. 
• Taking a second mortgage increases the risk of foreclosure if you can’t pay the loan.
• You don’t have the option to change your original mortgage terms when you take a second mortgage.

Who Should Consider a Second Mortgage?

You might choose to get a second mortgage for a major renovation project to increase the equity in your home or to consolidate debt. Home equity loans work best when you have a single project or specific dollar amount in mind. 

“Home equity loans are perfect for people who need a short-term solution,” Lerner says. 

For example, if you need to replace a roof or remodel a kitchen or bathroom, a home equity loan could give you the funds you need. A home equity loan usually works better than a HELOC for debt consolidation. 

On the other hand, a HELOC works well for ongoing expenses like a long-term renovation project or ongoing medical expenses. You can also consider getting a HELOC if you have additional expenses or are unsure of amounts. 

What is Refinancing?

In the case of mortgage refinancing, you have the option to replace your primary loan with a new one. You can choose a new lender, change the loan term, get a new interest rate or change loan types. Your new loan will repay the original mortgage, and you’ll pay the agreed-upon interest rates at closing. Although closing costs can get expensive, lower interest rates can lead to long-term savings. 

Types of Refinancing

There are two main types of mortgage refinancing you can consider. 

Cash-Out Refinancing

With cash-out refinancing, you will take out a home loan greater than your current mortgage and be provided the difference in cash. You’ll then make new monthly payments based on the new loan, which may come with lower interest rates. 

A cash-out refinance is a good option instead of a second mortgage but will require additional closing costs. Find some of the best cash-out refinancing lenders here. 

Rate and Term Refinancing

A rate-and-term refinance allows you to change the interest rate, term or both. You can get a rate-and-term refinance on an existing mortgage without advancing additional funds. A rate-and-term refinance is also known as a no-cash-out refinance.

Unlike a cash-out refinance, you won't get new money from the loan at closing. A rate-and-term refinance may carry lower interest rates than cash-out refinances, but you won't get additional funds. 

Rate and term refinancing makes sense if interest rates have dropped significantly or if your credit score has improved substantially. You can learn more about a rate-and-term refinance here. 

Pros

• Change mortgage rate and terms
• Possibility to secure a lower interest rate, especially if your credit score has increased
• Option to refinance with shorter or longer terms so current payments can meet your financial goals
• One monthly mortgage payment
• Refinance up to 100% of the home's equity 
• With a cash-out refinance, you don't have limits on the equity you can refinance 
• In case of a rate refinance with a longer term, your monthly payments may go down

Cons

• Monthly payments may increase, especially in a cash-out refinance. 
• You’ll have to pay closing costs ranging from 2% to 6% of your loan amount. 
• You could have a higher interest rate, especially if interest rates have increased.

Who Should Consider Refinancing 

Refinancing your home is a good option if you want to change your loan's rate or terms. If you need access to some of the equity in your home simultaneously, a cash-out refinance might be right for you. With a cash-out refinance, you can consolidate debt or pay for a large expense while securing a better term.  

A rate-and-term refinance can be a good option if you can secure a lower interest rate or need a longer mortgage term. In either case, you will need to cover closing costs. However, interest rates are usually lower on refinancing compared to second mortgages.

How to Choose Between a Second Mortgage and Refinancing

While deciding a second mortgage versus refinancing is personal, doing some math to objectively compare the options can make the decision easier. Do you need access to a large sum of cash? A second mortgage is probably the better choice for you. 

Cash-out refinancing typically pays out less money than second mortgages, but it may also help lower your interest rate and monthly payments. If you’ve improved your credit score or interest rates have fallen, a simple rate-and-term refinance may be the best option for long-term financial stability. 

Consider the following:

• Has your credit score improved?
• Are average interest rates higher or lower than when you got the mortgage?
• How much will you pay to refinance versus a second mortgage in closing costs?
• How much will each loan cost in total interest, assuming you pay off the mortgage and don’t sell or refinance the home again?

Why You Should Trust Us

Benzinga has offered investment and mortgage advice to more than one million people. Our experts include financial professionals and homeowners, such as Anthony O’Reilly, the writer of this piece. Anthony is a former journalist who’s won awards for his New York City economy coverage. He’s navigated tricky real estate markets in New York, Northern Virginia and North Carolina.

For this story, we worked with Jason Lerner, an area manager for First Home Mortgage and a 22-year mortgage industry veteran. 

Frequently Asked Questions 

Sources

• Jason Lerner, area manager for First Home Mortgage and a 22-year veteran of the mortgage industry