Every time you make a mortgage payment, you gain some equity in your property. And you may already know you can use this equity to borrow some money by taking a refinance or a second mortgage. But what are the differences?
Refinancing is the process of replacing your primary mortgage with an entirely new loan that pays off the existing mortgage. Homeowners often refinance a mortgage to obtain a lower interest rate, change the loan term or get some cash out. And no doubt, there are two common types of refinances, rate and term refinance and cash-out refinance.
A rate-and-term refinance allows you to change your loan setup without affecting your principal balance. It allows you to lower your monthly payments by taking a longer term or save on interest with a shorter term. You can also refinance to a lower interest rate if the market rates are lower. However, do note there will be some costs associated with closing and funds from the new loan paying off the old loan.
On the other hand, cash-out refinance allows you to take out some cash from the home equity by taking a new loan with a higher principal. For example, if you currently have a loan with a $100,000 principal balance and you need $50,000 cash for other uses. You can apply for a new loan valued at $150,000 and emerge with $50,000 cash and a new mortgage with a $150,000 principal.
You can also take out a second mortgage to obtain some extra money. Unlike a cash-out refinance, you will get a separate mortgage that stands alone from the original home loan. The second mortgage is also secured by the property but is subordinate to the first mortgage. If the homeowner defaults on the loans, lender holding the first mortgage has priority to proceeds from a sale or foreclosure. Therefore, the second mortgage lender carries more risk and often requires a higher interest rate.
Refinance and second mortgage can benefit homeowners if it is used correctly. When it comes to deciding the best move for you, consider your financial needs, the equity available and current market situation. If current interest rates are lower, refinance may be the better choice because you will get a lower rate on your entire loan and cash out if needed. If rates have gone up, taking out a second mortgage may make more sense than refinancing the whole loan at a higher rate.