Choosing the right loan is just as important as choosing the right lender. You may be trying to decide whether a cash-out refinance or a second mortgage would work best. Or you may even be wondering, what is a second mortgage?
Allow us to break it down for you. Solarity Credit Union has extensive experience helping people just like you explore their loan options in Washington State. We’ll explain exactly what a second mortgage is and go over the two main types of second mortgages.
What is a second mortgage?
In some ways, a second mortgage functions similarly to a first mortgage. Once you close on your second mortgage, a lien will be filed on your property and will take second priority, after your first mortgage. You will then have two loans that use your home as collateral: your first mortgage and your second mortgage.
Keep in mind that most people can only qualify for a second mortgage once they free up equity in their homes. In other words, if you financed the full amount of your home with a zero-down-payment loan, you will have to pay down some of your mortgage to free up equity.
Wait, what’s equity?
When we refer to a home’s equity, we mean the market value of the home (what an appraisal would reflect, for instance) minus the amount owed on the home. The difference is the amount of the home that you actually own. This amount is generally how much collateral you have to borrow against if you want to take out a second mortgage.
Most lenders will not allow you to borrow an amount equal to 100% of your home’s value, however. That is why when you first closed on your home, you more than likely had to make a down payment toward your purchase. The amount of your home’s value that you can borrow against depends on a number of factors, including property type, creditworthiness and your lender.
What is a cash-out refinance?
An alternative option to a second mortgage is a cash-out refi, which is a refinance of your existing mortgage for a higher amount than your outstanding balance. In other words, you pay off your original mortgage with the new loan, and the difference between the amount you owe on your current mortgage and the new amount you’re borrowing goes directly to you.
Second mortgage options
A home equity line of credit, or HELOC, is a unique loan product. HELOCs are among the most flexible loan options because you borrow only the amount you need when you need it.
Think of it as a credit card, for instance. You have a credit limit up to a certain amount, but your monthly charges may total less than the full amount of your credit limit. You pay off the card each month and then borrow more as needed. The more you pay down each month, the more of your credit limit you free up. A HELOC functions much the same way, though HELOC interest rates tend to be far lower than credit card interest rates.
A Solarity Credit Union HELOC comes with a 5-year draw period and a 15-year repayment period. During the five-year draw period, you are only required to pay interest on the amount you borrow. Since you’re only making payments on the interest for the first five years, a HELOC is the perfect option for a homeowner who wants to free up as much money as possible.
Once the draw period ends, you have 15 years to pay back the borrowed amount plus interest. If you’re interested in learning more or want to apply for a HELOC with us, visit our application page for additional details.
In some instances, you may want to opt for a more traditional loan. If so, you also have the option of closing on a second mortgage that functions much like your first mortgage. A loan allows you to borrow a fixed amount and then make monthly payments toward both the principal and interest over the life of the loan.
If you know exactly how much you want to borrow and are only planning to use the money for a one-time expenditure, a more traditional loan may be preferable to a HELOC. If you’re leaning toward a loan and want to get a sense of how much your monthly payment will be, you can use Solarity’s loan calculator to crunch the numbers.
Should you choose a second mortgage or a cash-out refi?
The above breakdown should give you a sense of whether a HELOC or loan would serve you best. But you may still be wondering which is the better option when it comes to a second mortgage or a cash-out refinance. The short answer is that it’s really going to depend on each loan’s terms and conditions.
For instance, you may have to pay closing costs or incur a loan origination fee. If so, you’ll certainly want to take the cost of the loan into account when deciding how to proceed. Also, check if there is any sort of prepayment penalty for refinancing your existing mortgage within a certain time period. While prepayment penalties for mortgages are rare, it is still a good idea to double-check whether you will be assessed one.Ultimately, you will have to consider the interest rate being offered for each loan, the cost of the loan (origination fees, closing fees, and so forth) and the loan terms to decide which is the ideal option for you. If you need help finding the right loan product, Solarity Credit Union is here to assist you. Speak with a Home Loan Guide about a second mortgage or cash-out refinance. We use our skills and expertise to guide you through the process.