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

If you need additional funds, you could access equity from your home via a second mortgage or refinance. But do you need a second mortgage or a refinance? While both offer access to equity in your home, they come with significant considerations. This article takes a closer look at the differences between a second mortgage and a mortgage refinance so you can make the best decision for your situation. Find the second mortgage versus refinance pros and cons below. 

What Is a Second Mortgage?

A second mortgage is a home loan that uses the home as equity. You can take out a second mortgage while still repaying your original mortgage. 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.

To get a second mortgage, you must have equity built up in the home and maintain a minimum amount of equity. The increase in home prices since early 2020 means that many homeowners have significant equity in their homes. 

You can tap into this equity with a second mortgage that uses the home as collateral for the debt, just as the original mortgage does.

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 600 or higher

Types of Second Mortgages

The main types of second mortgages are home equity loans and home equity lines of credit (HELOCs). Here is how each differs and when to consider each. 

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

A home equity line of credit is also a type of second mortgage but 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. 

When Should You Get a Second Mortgage?

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

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. 

Pros and Cons of a Second Mortgage

Getting a second mortgage has pros and cons. While it can give you access to extra cash, you're borrowing from yourself and will need to repay it. Here is an overview of the pros and cons. 

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.

What Is Refinancing?

In the case of mortgage refinancing, you have the option to replace your primary loan with a new loan. You can choose a new lender, change the loan term, get a new interest rate or change loan types. Refinancing means you'll get a few loans and be able to repay the original mortgage. This still comes with closing costs, but lower interest rates can lead to long-term savings. 

Types of Refinancing

There are several types of mortgage refinancing you can consider. 

Cash-Out Refinancing

With cash-out refinancing, you will take out a loan on a property you own. Based on the loan amount, you could potentially access additional home equity. The amount above the cost of the transaction, payoff of existing liens and related expenses can be taken as cash for new expenses for the borrower. 

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. 

When Should You Refinance Your Home?

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.

Pros and Cons of Refinancing

There are both pros and cons to refinancing, including:

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 mortgage and 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, which range from 2% to 6% of your loan amount. 
• For example, refinancing a $200,000 loan could cost $4,000 to $12,000 at closing, or you may roll these costs into the loan, increasing your monthly payments.
• You could end up with a higher interest rate, especially if interest rates have increased.

Deciding on a Second Mortgage vs. Refinance

While the decision of a second mortgage versus refinancing is personal, doing some math to objectively compare the options can make the decision easier. Consider:

• Do you need to access cash or tap into equity? 
• Has your credit score improved?
• Are average interest rates higher or lower than when you got the mortgage?
• How much will you need to 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?

Based on the answers to those questions, you can use a mortgage calculator to compare options, total costs, monthly payment amounts and the repayment schedule. If you're still unsure, consider a home equity loan versus a cash-out refinance or a HELOC versus a refinance. You can also learn more about how to get a second mortgage. 

Frequently Asked Questions