Could Your Second Mortgage Ruin Your Refinance
Second mortgages can create difficulties when you refinance. By subordinating your second mortgage to your new first mortgage, these challenges can be overcome.
When might your second mortgage pose refinancing problems?
Ideally, you replace your first and second mortgage with a new first mortgage when you refinance. That generally gets you the lowest mortgage rates. But you might not always want or be able to do that. For example:
- Your home equity loan or line of credit might have an ugly prepayment penalty.
- You may prefer to keep a HELOC open for business purposes or other reasons.
- Your new first mortgage would have to have mortgage insurance .
You can resolve these issues by keeping your second mortgage and subordinating it to your new first mortgage.
What is mortgage subordination?
Here’s how mortgage subordination works, and why it’s required:
Home equity loans and HELOCs are often called second mortgages because their lien holders are in second position, behind the lien holders of the first mortgage. This means that should you default on your home loan and end up in foreclosure, the first lien mortgage lender is paid from the proceeds of the foreclosure sale before anyone else. Other lenders are called “junior lien holders” and are repaid only after the first mortgage lender’s claim is fully satisfied. Often, there is no money left to repay junior liens. So home equity lenders take a riskier position, which explains why these loans don’t carry the best mortgage rates.
What Can I Use A Second Mortgage For
While you can use a second mortgage for pretty much everything you need, it is best to put the funds borrowed towards something that will ultimately increase your net worth. Examples of these types of investments include:
Home Improvement – Investing the money borrowed through a second mortgage to make home renovations and improvements will typically result in an increased value for your home, which will increase your net worth. This is because you will be able to sell the house at a higher price in the future. Undertaking a home improvement project is by far the most common reason why homeowners choose to borrow more funds.
Pay off existing debts – If you have current outstanding debts that you continue paying interest towards, you can pay off the amount by taking one second mortgage as a lump sum. However, there is a risk associated with this technique. A second mortgage is a secured loan, so you would be putting your house on the line if you fail to make the mortgage payments.
Avoid paying for Private Mortgage Insurance – With conventional loans, if yourLoan-to-Value ratiois less than 80%, then you will have to pay forprivate mortgage insurance. If you dont want to pay for PMI, you can get a second mortgage to keep your home equity at 20%. This is sometimes referred to as apiggyback loan.
When Combing Your First And Second Mortgage Doesnt Make Sense
Combining two mortgages isnt always simple though. Lending regulations have tightened over the years, and depending on your borrower profile, lenders may be hesitant to shell out the cash.
Cash out refinance limitations. If your second mortgage is a HELOC, consolidating both loans may be considered cash out financing and subject to cash out loan-to-value limitations. Most banks limit cash out loans to around 80 percent of the value of the home. If you owe more than 80 percent between your mortgages, it may not be possible for you to combine your mortgages. If lenders do approve a consolidation, the amount you can borrow may be reduced.
Additionally, combining mortgages wouldnt make sense for you if:
Its also important to calculate your breakeven point. Refinancing, regardless of which product you use, costs money. Its common for the fees to be recovered by the long-term savings, but only if youll be living in your home long enough to redeem the reward. Youll need to do the math to see if this is the case for your situation.
Recommended Reading: How Long Can You Be Pre Approved For A Mortgage
Comparing Mortgage Refinance Vs Heloc
When looking to refinance your home, homeowners can choose from many options, like home equity loans, cash-out refinance, and a home equity line of credit . When comparing a mortgage refinance vs. a HELOC, borrowers will find similarities and differences to help choose the one thats right for them.
While a traditional mortgage refinance changes the terms and rates of your existing mortgage, a cash-out refinance pays off your original mortgage and allows you to withdraw additional funds through a new mortgage loan. This additional borrowing mimics a HELOC but, instead of a line of credit, a cash-out refinance offers you a lump sum when borrowing.
If youre looking to consolidate debt or have a home renovation project in mind, Discover® Cash-Out Refinance may be the best option for your financial situation when compared with a HELOC.
Curious how much you can borrow using your homes equity? Use Loan Amount Calculator from Discover to get an estimate.
The Types Of Refinances
There are two types of refinances known as a cash-out refinance and a rate and term refinance:
- Cash-out refinance: A cash-out refinance lets you access your equity in exchange for a higher principal. For instance, if you have a mortgage with a $120,000 principal balance and you want to do $30,000 worth of repairs on your home, you would accept a loan of $150,000. Youll then receive the $30,000 in cash after you close.
- Rate and term refinance: This type of refinancing lets you adjust how your mortgage is set up without impacting your principal balance. If you want to lower your monthly payment, you can accept a longer term. If you want to save on interest and own your house faster, you can shorten your loan term. You may also be able to refinance to a lower rate if market rates are now lower than when you obtained your mortgage.
Also Check: What Type Of Mortgage Loan Do I Have
Ask Your Second Lender To Subrogate Its Lien On Your Home
In simple terms, subrogate means your second mortgage lender agrees to stay in the second position and let your newly refinanced mortgage be the first to get paid off if your home goes into foreclosure.
This is much more likely to happen if the same company holds your first and second mortgages than if two different companies or investors are involved, says Sam Garcia, publisher of MortgageDaily.com.
If you have your first mortgage with one lender and your second with another, ask your second mortgage lender if it will refinance your first.
Requirements For Keeping A Second Mortgage With A Va Loan
Borrowers can opt to refinance their VA home loan all while keeping a secondary mortgage. The Department of Veterans Affairs has requirements for doing so, including the following:
- The mortgage lender must submit documentation explaining the source, loan amount and repayment terms of the secondary mortgage, while also disclosing the veteran borrowers and co-borrowers agreement to these terms.
- The new VA-backed loan becomes the primary mortgage and the second mortgage is subordinated to the VA-backed loan.
- Money from the second mortgage may be used to cover closing costs and other costs, but it cant be used to cover a down payment required by the VA.
- The interest rate on the second mortgage cannot exceed industry standards for second mortgages, but it can exceed the rate of the VA-backed home loan.
For additional terms and conditions related to secondary borrowing, please visit the VAs website.
Don’t Miss: What Is The Going Interest Rate On Mortgages
How Often Can I Apply To Refinance My Mortgage
While you should only ever refinance your home with good reason, there are no rules that limit how often you can refinance. Lenders, however, will typically set a limit. Keep in mind that your credit report will be pulled each time you refinance, and when this happens too frequently it can negatively affect your credit score. Since your credit score is also a factor in a lenders decision to approve your refinancing, a lower score would also lower your chances of approval.
How Does Refinancing Work
The application for a refinance is similar to your original mortgage application. First, youll submit your financial documentation to the lender, and then the lender will underwrite your loan. In most cases, before you can refinance, you may also need an appraisal. With a refinance, you may need to pay for some of the same items as during your original mortgage process, including:
- Application fees
- A home title search
After the underwriting and appraisal are completed, the next steps are closing and signing your new loan. If you obtain a cash-out refinance, youll likely receive your money a few days after you close on your loan.
As with a second mortgage, keep in mind that you may not be able to access all of your home equity when you choose a refinance.
Read Also: How Much Can You Get On A Reverse Mortgage
Know What You’re Starting With
To understand what happens when you consolidate you have to know a few things about the current loans you have. If, when you go to consolidate loans, you realize that your second mortgage was used to pull cash out of your home for some reasoncalled a cash-out loanit may add cost to the new loan and reduce the amount for which you qualify. Cash-out loans are priced higher, lenders say, because the borrower is statistically more likely to walk away from the loan if they get in trouble.
Then there is the rate/term refinance . This type of loan is simply an adjustment on the interest rate and terms of your current loan. The loan is considered safer to the lender because the borrower isnt pocketing any money or reducing the amount of equity they have in the property. You may have refinanced recently when mortgage rates dropped to historic lows. A mortgage calculator can be a good resource to budget for the monthly cost of your payment.
Why do these distinctions matter? According to Casey Fleming, branch manager at Fairway Independent Mortgage Corporation and author of The Loan Guide: How to Get the Best Possible Mortgage, they are important because the terms and the amount you will pay on new mortgages could be very different.
Resubordination Can Be Problematic These Days
Resubordination is usually the path of least resistance, although it does take time and can involve extra fees. Keep in mind, however, that home equity lending has tightened during the pandemic and these days many lenders will simply not want to be bothered or want to take on additional risk.
If you want to go this route, before you can refinance your primary mortgage, your lender must submit a subordination package all of the documents supporting the request to the institution holding your home equity loan or line of credit. The second mortgage lender, if they want to go along, typically charges a few hundred dollars to review the package, and approval can take up to six weeks.
Read Also: Does Having A Mortgage Help Your Credit
Can You Refinance A Primary Mortgage When You Have A Second Mortgage
You can still refinance your primary mortgage even if you have a second loan on your home. That second mortgage just makes the process more complicated.
There are two ways to close a refinance of a primary mortgage when you have a second mortgage: You can refinance both your primary and second mortgages into one loan. Say you owe $150,000 on your primary mortgage and $50,000 on your second mortgage. You’d need to refinance the two loans into one loan of $200,000, or more if you are rolling closing costs into your new loan. If you don’t have 20% equity in your home, you won’t be able to do this.
But what if you want to keep that second loan? Maybe your second loan is a HELOC and you like the flexibility of having a line of credit against your home’s equity. You can refinance your primary mortgage if the lender who holds your second mortgage agrees to what is known as resubordination.
Under this process, the lender of your second mortgage agrees to remain in the second, or subordinate, position after you refinance your existing primary mortgage. Usually, your second mortgage would become your primary loan after such a refinance because it is the older debt. You’ll need to request, then, that the holder of your second loan agrees to waive this position and remain in the second or subordinate position after your refinance closes.
Pros And Cons Of Home Equity Loans
There are several advantages to home equity loans that can make them attractive options for homeowners looking to reduce their monthly payments and simultaneously release a lump sum. Refinancing with a home equity loan can offer:
- Lower, fixed interest rates than your previous mortgage
- Lower monthly payments due to lower interest rates and a smaller principal
- A lump sum that can be used for any purpose, including renovations and improvements to your property that, in turn, can raise its value
On the other hand, home equity loans come with risks that you should be aware of:
- Your home secures the loan, so your home is at risk if you fall behind on your loan repayments.
- With a traditional home equity loan, you have to borrow a set amount of money. If you dont end up needing the whole amount, you can be stuck paying interest on a portion of the loan you dont use. This is why HELOCs are a better option for homeowners who need to cover ongoing, unpredictable expenses.
- You cant get a home equity loan with too much debt or poor credit. This bars some people from being able to access the equity in their homes.
Mortgage lending discrimination is illegal. If you think youve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau and/or with the U.S. Department of Housing and Urban Development .
Don’t Miss: Is Fha Mortgage Insurance For The Life Of The Loan
Know Where Your Credit Stands
The first step in taking out any type of home loan is to understand what youre likely to qualify for, according to your credit history. The better your credit, the better the loan terms you may be offered and the higher your likelihood of loan approval.
Request your free credit reports from each of the three major bureaus and review them for inaccuracies. If you find any errors, be sure to dispute them immediately.
Pros Of A Second Mortgage
- Second mortgages can mean high loan amounts. Some lenders allow you to take up to 90% of your homes equity in a second mortgage. This means that you can borrow more money with a second mortgage than with other types of loans, especially if youve been making payments on your loan for a long time.
- Second mortgages have lower interest rates than credit cards. Second mortgages are considered secured debt, which means that they have collateral behind them . Lenders offer lower rates on second mortgages than credit cards because theres less of a risk that the lender will lose money.
- There are no limits on fund usage. There are no laws or rules that dictate how you can use the money you take from your second mortgage. From planning a wedding to paying off college debt, the skys the limit.
Also Check: How To Estimate Your Mortgage Payment
Gather Information On Your Credit History And Debt
You should do a simple credit check before attempting to refinance your second mortgage, as well as evaluate your financial situation. Favorable interest rates are given to people with excellent credit and a low DTI ratio. If your credit score has fallen since you refinanced your home, you may want to spend a few months attempting to raise your credit score and decrease your DTI ratio.
Your lender may look at your other debts to determine your eligibility.
How We Make Money
The offers that appear on this site are from companies that compensate us. This compensation may impact how and where products appear on this site, including, for example, the order in which they may appear within the listing categories. But this compensation does not influence the information we publish, or the reviews that you see on this site. We do not include the universe of companies or financial offers that may be available to you.
Recommended Reading: How To Add Spouse To Mortgage Loan Without Refinancing
Interest Rates And Fees If You Borrow On Amounts You Prepaid
You pay either a blended interest rate or the same interest rate as your mortgage on the amount you borrow. A blended interest rate combines your current interest and the rate currently available for a new term.
Fees vary between lenders. Make sure to ask your lender what fees you have to pay.
You may not have to make any changes to your mortgage term.
What Are The Advantages Of A Second Mortgage
When you take on a second mortgage, you may enjoy several advantages, including:
- Keeping current loan terms: If your primary mortgage has a great interest rate, you can keep this rate when you secure a second mortgage, as a second mortgage wont replace your existing loan. Rather than change your current loan terms, a second mortgage will add an extra payment to your monthly expenses.
- Paying fewer closing costs: With a second mortgage, a home equity loan lender tends to cover most or all of your closing costs. Since you may not have to pay closing costs at all, you can save thousands of dollars.
- You can select whether you want a HELOC or a home equity loan. If you want a lump sum, you may want to select a home equity loan. If you want to tackle a home renovation or another ongoing project and you dont know exactly how much money you may need, you may want to choose a HELOC instead.
Don’t Miss: Is Quicken Loans A Mortgage Company
