Second Mortgage vs. Refinance: Which is right?

If you need cash and have owned your home for quite a while, you may be tempted to use the cash equity in your home.

However, there are several ways this can be accomplished and depending on your circumstances, not all of them would be good for you. How can you decide what is best?

The primary difference between a refinancing product and a second mortgage is that the refinancing product simply takes your existing loan and it at a lower interest rate. Simply refinancing does not give you cash out immediately, but rather gives you a savings over time. However, there are refinancing products that do offer a cash out feature. In those products you agree to refinance your mortgage for more than you actually owe and the difference is given to you, or cashed out. Most financial advisors ask five important questions to help their clients make the same decision. Answer these questions and see if a second mortgage or a refinance is best for you.

What are your long-term goals for this home?

Ask yourself whether you plan to live in the home for another five to 10 years. If the answer is no, then most likely refinancing is not going to be the answer. This is because interest rates can fluctuate and it can take at least that amount of time for you to replace the cashed out amount.

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A second mortgage may suit you better in these circumstances because if you sell the home you can include the second mortgage as part of the selling price. This is particularly beneficial if you bought your home as a short-sale, or below market value.

What is the interest rate currently?

When interest rates are low, refinancing with cash out is the better choice. Then you are receiving not only cash back, but you are receiving a lowered interest rate on the rest of the existing loan. Second mortgages are not beneficial because you still have the first mortgage at the higher interest rate.

Which of these financial products are you most likely to qualify for?

The cash out refinancing product is, in general, the easier financial product to qualify. Lenders tend to favor this type of product because it places them as a primary creditor. Since home equity loans are basically second mortgages the creditors are second in line, legally. That means they are more likely to scrutinize your credit and require larger closing costs.

How long do you want the payment terms to be?

If you want to take as much time as possible to pay back the loan, then a home equity loan should be avoided. The longest they are offered is for 15 years, whereas cash-out refinancing is like another mortgage and can last as long as 30 years. The ideal situation is to go for the shortest term you possibly can while still having a payment each month you can afford.

What type of mortgage package do you currently have?

If your home loan is an adjustable rate, then you may benefit from the refinancing and cash out choice. This is because the interest rates are lower than they were years ago and refinancing for a fixed rate can lock in the lower rates for the life of your loan. Adjustable rates do just that, they change with the fluctuations in the market. Yes, you benefit when the rates are low, but when the rates go higher you do not.

Do you need the money all at once?

If you only need some of the equity from your home, then a home equity line of credit (HELOC) may be a good product for you. These are a different type of home equity loan in that you are offered a line of credit against the equity in your home. It cats much like a credit card allowing you to draw out the money as you need it. When you apply for a HELOC you are approved for a certain amount to borrow and the equity in your home is used as collateral against that amount. The benefit to a HELOC is that you do not have monthly payments as you would with a second mortgage or refinance on your first mortgage. You only pay when you borrow.

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Home equity packages have the lower closing costs, some as low as $300. Closing costs on a refinance can be as much as 1.2 percent. So, for example, if your home is appraised at $200,000, then the closing costs for a refinancing package would run approximately $2402.00. That is excluding title insurance fees.

How much time do you have?

Refinancing your home for a cash-out package can take as long as it originally did to purchase your home. The average is 30 days and you must provide all of the usual paperwork including personal information and income/expense figures. Home equity loans generally close in a week and do not require private mortgage insurance (PMI). However, unlike refinancing packages, home equity loans can often have prepayment penalties.

What’s your credit score?

Your ability to engage with either of the financial products is dependent on where you stand with your credit score. If your credit score is lower than when you first purchased your home, then refinancing may not be in your best interest because the rates you will be offered may be higher than before.

How will you use the money?

In general if you can get the money out of your home and use at least a portion of it to pay off, or pay down, debt, then you are in a win/win scenario. Better still is refinancing at a lower rate, taking the cash out option and using part of it to pay down debt. Then you not only have paid down your debt but you have secured a lower rate for your first mortgage.

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