Refinancing a second mortgage, such as a home equity loan or HELOC, is a common strategy to secure a lower interest rate. While refinancing one second mortgage with another is straightforward, it becomes more complex when refinancing both the first and second mortgages simultaneously. Here’s a detailed look at how refinancing a second mortgage operates.
What is a second mortgage?
A second mortgage is essentially an additional loan secured by your home’s equity. This equity serves as collateral for the new loan.
When refinancing a second mortgage, or even considering a refinance for your primary mortgage, it’s crucial to understand that repayment priority is assigned based on the age of the loan. In the event of default or sale of the house, the lender of the older loan is prioritized for repayment. This hierarchy is significant when refinancing both first and second mortgages.
Types of second mortgages
Here are three types of second mortgages:
- Home equity loan: This type allows you to convert your home equity into a lump sum of money. Typically, you repay it with a fixed interest rate over a period ranging from 5 to 30 years.
- Home equity line of credit (HELOC): A HELOC also utilizes your home equity to provide funds. It operates as a revolving line of credit that you can draw on for about 10 years. Subsequently, you repay the borrowed amount over 20 years, usually at a variable interest rate.
- Piggyback mortgage: This mortgage helps finance a down payment on a house. It enables you to avoid paying mortgage insurance or obtaining a jumbo loan.
5 steps for refinancing your second mortgage
Refinancing a second mortgage resembles refinancing any other loan. Here are the steps involved:
- Check your eligibility: Ensure you have adequate equity and a good credit score to qualify for refinancing.
- Determine your goals: Decide whether you aim to lower your monthly payments, secure a lower interest rate, or achieve other financial objectives. This will direct your search for a suitable loan.
- Compare lenders: Evaluate the refinancing options offered by various lenders. Reading reviews about mortgage lenders can assist in narrowing down your choices.
- Apply: Complete an application and await approval. Prepare to provide financial documentation demonstrating your eligibility. The refinancing process may also involve home appraisals and similar procedures.
- Avoid applying for other loans: During the underwriting process, refrain from applying for additional loans as changes to your credit profile could impact your refinancing application negatively.
Can you refinance a second mortgage?
Borrowers can refinance a second mortgage with relative ease because the second loan remains subordinate to the primary mortgage. This means that refinancing the second mortgage does not alter the priority order for lenders seeking repayment in case of default.
To refinance your second mortgage, you’ll need to meet standard mortgage criteria, including having adequate equity, a good credit score, and sufficient income to support the new loan.
Pros and cons of refinancing your second mortgage
Before deciding to refinance a second mortgage, it’s essential to weigh the advantages and disadvantages to ensure it’s the right move.
Pros of refinancing a second mortgage
- Lower your interest rate, potentially saving money over time.
- Reduce monthly payments by securing a lower rate or extending the repayment term.
- Switch from a variable interest rate to a fixed rate, providing stability in payments.
Cons of refinancing a second mortgage
- Incur closing costs associated with the refinancing process.Face higher interest rates if market rates have increased or if your credit score has declined.
Can you refinance your primary mortgage when you have a second mortgage?
Yes, it is feasible to refinance your primary mortgage while having a second loan, but it involves complexities.
Typically, your primary lender holds the first claim if you default on your mortgage, with the second mortgage lender having the secondary claim. If you refinance your primary mortgage, your second mortgage will become the oldest loan against the home, giving the second lender precedence in foreclosing on it.
Most mortgage lenders are hesitant about this arrangement. To refinance your primary mortgage, you typically need the second lender to agree to resubordination, relinquishing their first claim in case of default back to the primary lender. Some lenders may not agree to this resubordination, and even if they do, it often involves paying fees.
If you choose this path, your primary mortgage lender must submit a subordination package—containing all the documents supporting the request—to the institution holding your home equity loan or line of credit. The second mortgage lender usually charges a fee of a few hundred dollars to review the package, and approval can take up to six weeks.
Options when resubordination is denied
If your home equity lender refuses to agree to resubordination but you still want to proceed with refinancing, there are alternative options available. One approach could be to pay off the second loan if you have sufficient funds, possibly through a cash-out refinance.
However, it’s crucial to maintain at least 20 percent equity in your property after the cash-out refinance to avoid paying private mortgage insurance (PMI). PMI could offset the savings you hope to achieve through refinancing.
Adding additional debt through a cash-out refinance may also make lenders more cautious about underwriting the new loan, potentially resulting in a slightly higher interest rate. Many lenders require a maximum loan-to-value ratio of 80 percent for refinancing, meaning the amount you borrow cannot exceed 80 percent of your home’s current appraised value.
Another option is to find a lender who can facilitate a simultaneous refinance of both your first and second mortgages. This approach allows you to retain the second mortgage credit line while securing a new first mortgage. A mortgage broker could be valuable in navigating these types of refinancing scenarios involving a second mortgage.