Cash strapped situations are not uncommon, and most individuals are likely to have found themselves in need of cash. In the case of homeowners who are already repaying a mortgage, this could pose a challenge. The need to access a sufficient amount of money alongside in addition to managing the existing loan repayment schedule makes it necessary to make a prudent choice.
The options available to property owners include opting for a second mortgage or going in for refinance. Both options have their share of advantages and drawbacks. It may be hard to zero in on one option without considering the benefits and the suitability for your specific needs.
Your choice of either second mortgage of refinancing should ideally be a need-based decision and should not be a sweeping choice. In other words, it is not a good idea to have a fixed mindset that one option is better than the other. It is true that each option offers benefits, but the actual benefits will suit specific situations, and hence your choice has to be a need-based decision.
Here is a feature by feature comparison between a second mortgage and a refinancing option. This will help you make the right choice depending on your specific needs. Before we look at the details, here is a little table that will give you a quick glance at the feature comparison.
|Two types – |
(1) Home equity loan
(2) Home equity line of credit
|Two types – |
(1) Rate/term refinance
(2) Cash-out refinance
|Lesser closing costs||Higher closing costs|
|Additional repayment apart from existing mortgage repayment||Existing and new loan rolled into a single repayment|
|Typically higher than the previous mortgage interest rate||Typically lower interest rate|
|Second lien on the property||Single lien on the property|
|Borrowings lesser than the full value of property||Borrowings possible for the full value of property|
|Original terms of the first mortgage will remain unchanged||Original terms of the mortgage will change – will be as per existing market rates|
Specific situations where the second mortgage is a more suitable option
- Imagine you are sprucing up your property or making some kind of an extension. You already have a mortgage on your property but are in need of funds to take up the work. You need to consider a few facts before going in for a second mortgage. Since a second mortgage will leave the terms of the first mortgage unchanged, it is essential to look at the interest rates. Check out the rate of interest of the existing mortgage and the present rates in the market. If there is a huge difference between the rate of interest of the first mortgage and the present market rates, it pays to go in for a second mortgage. Because most second mortgages are only for a relatively smaller amount than that of the original mortgage, it does not pay to go in for an option that changes the better terms of the first mortgage.
- Similarly, if you do not want to make any upfront payment towards closing charges for the loan, a second mortgage is a good choice. The mortgage lenders take care of the closing charges, and you will not have to fork out charges.
- Finally, if you are not sure of the exact amount you need, you can opt for the credit’s home equity line. This permits you to draw credit as per your requirement. This will ensure that you do not end up with surplus cash in your hand, which you may splurge on unplanned and unnecessary expenses. Another outcome of availing a home equity line of credit is the benefit of beginning your payout in a deferred manner. In other words, you being repaying the principal amount only after you have completed drawing the final amount. This removes the burden of payments when you are in the middle of a renovation.
Specific situations where refinance is a more suitable option.
- Imagine you are need of funds quickly to meet home improvement or extension costs. If you are already having a mortgage with a lien on your property, you may want to restructure the loan. In other words, you may be looking for additional funds without having to stress out your repayment. When you go in for refinancing, you can roll the existing loan with the new loan into a single loan. This restructuring permits you to get a tenure and repayment schedule that is easy to fulfill.
- Additionally, when you choose the refinancing mode, you will be effectively reducing the interest rate from the previous rate of interest. This is because a single lien will apply, which reduces the risk of exposure of the lender. Therefore, if you are presently in a mortgage with a high-interest rate, refinancing will help you get a lower interest rate.
- Other suitability criteria include the need for more funds. When you go for refinancing as an option, you will get the advantage of extracting the property’s full value in the loan. Therefore, if your requirement is extra funds, then refinancing is a good choice.
- The best advantage of refinancing is the ability to repay the loan through single monthly repayment options. This will reduce the stress of having to make multiple monthly payments. On a comparative scale, this works to your advantage. For instance, if you already had a mortgage on your property, you would have been paying ‘x’ monthly repayment. When you go in for a second mortgage, the ‘x’ amount remains unchanged. You will then have to make an additional ‘y’ amount monthly towards the second mortgage amount. With a refinancing, you will only have to make an altered ‘x’ amount as monthly repayment, reducing your exposure.
Dealmakers and breakers – what works for and against each option during specific situations?
There are specific situations when each option may be or not be the best choice for your requirement. Here is a look at some of the deal makers and deal breakers in each option. Ask yourself the following questions – this will help you go with or rule out a particular option depending on the requirement.
Q. Are you short of cash and do not relish the prospect of having to shell out two or three thousand dollars towards closure charges?
You need to choose the second mortgage option as the lender handles the charges in such a situation. It is true that when you opt for refinancing, the closure charges can also be rolled into the loan, but this puts the burden on you eventually.
Q. Are you presently stressed out having to fulfill your obligations towards the first mortgage? Do you think it will be difficult to handle a second repayment?
Here, the best choice is to refinance.
Q. Do you want to extend the tenure of your repayment of the combined mortgage while availing an additional loan amount?
Here again, the best option is to refinance. You get to actually alter the repayment tenure and also get a marginal reduction in interest rates.
Q. Are you unsure of how much you need for your requirements?
If you are not sure of the actual requirements, then the best option is to go in for a second mortgage (home equity line of credit). Refinancing works only when you are aware of your actual requirements.
Regardless of your decision to go with one or the other choice, it is essential to check out various other advantages of each option. Remember, your focus should never leave the interest rates or the monthly repayment exposure.
Loans should always be a prudent decision and never made in haste. Many borrowers end up borrowing more than they can repay, and this is attributed to over-optimism of earnings, despite clear evidence to the contrary. Therefore, weigh in all the options carefully before you sign on the dotted line.