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Why You Should Choose Refinancing Over a Second Mortgage

Posted by  on Feb 08, 2010
 
If you want to tap into the equity of your home, you have two choices. You can refinance your existing mortgage and remove some of the equity as cash, or you can obtain a second mortgage, commonly known as a home equity loan. For a variety of reasons, refinancing your existing mortgage is usually the best option.

Refinancing Versus a Second Mortgage

Refinancing is usually done for one of three reasons. In the first scenario, a property owner wants to take advantage of a lower interest rate than they were able to obtain when they got their first mortgage. Alternatively, they may want to refinance to a mortgage with shorter terms, so they can pay the mortgage off sooner and save thousands of dollars in interest repayments. In the third, the mortgage holder refinances their mortgage and exchanges some of the equity they have built up in their home for cash. In either case, refinancing a mortgage works very similarly to obtaining your first. There are closing costs to pay, and you will require a good credit rating and income to debt ratio to qualify for a good interest rate.

A second mortgage, or home equity loan, does not allow you to obtain a lower interest rate on your existing mortgage; however it does provide you with a way of tapping into the equity you’ve built up in your home. A second mortgage also requires payment of fees, including origination fees, application fees, and even withdrawal fees when you draw the money you borrow. Your eligibility will depend on your credit rating and income to debt ratio, just as with a conventional mortgage. One of the downsides is that if you want to opt for a home equity line of credit, you will be stuck with an adjustable interest rate, meaning that if interest rates rise, your repayments do too.

One of the most pressing reasons to choose refinancing over a second mortgage is simply that doing so will usually allow you to borrow at a lower interest rate. The second mortgage is essentially a second lien on your home, meaning that should you default on payments of either your first mortgage or second, the second mortgage is second in line in terms of determining which loan is paid first. The higher level of risk for the second mortgage lender translates into a higher interest rate for you, the borrower. For this reason, a second mortgage can also be more difficult to obtain than simply refinancing your home, since a lender knows that the first mortgage will always take priority in the event of a foreclosure.

Both refinancing and second mortgages offer you the chance to consolidate debt”such as credit card debt”and generally use the cash you obtain in any way you please. There are good reasons and bad reasons for exchanging your equity for cash. In general, anything that offers you a long-lasting benefit is a solid reason for doing so. In the case of credit card debt, however, neither refinancing nor a home equity loan is the best way of dealing with the situation, unless you’re 100% positive that you can control your credit card spending in the future.

Refinancing Offers Greater Benefits

All of this simply means that refinancing your existing mortgage offers advantages that getting a second mortgage does not. By refinancing, you can not only take the cash-out option, you also have the chance to obtain a lower interest rate on your mortgage at the same time. The second mortgage doesn’t offer this opportunity, and you’ll typically be paying a higher interest rate on the second mortgage into the bargain.

Granted, refinancing your existing mortgage will usually include higher finance charges than a second mortgage. However, if you are able to lock in a lower interest rate, those finance charges will eventually be paid for with the money you save in interest.

In a straight-up comparison, refinancing an existing mortgage offers far greater benefits than does a second mortgage. In both cases you are exchanging equity for cash, but the second mortgage does not also allow you to reduce your debt total by locking in a lower interest rate for your first mortgage, or by refinancing to a mortgage that allows you to pay the debt off sooner.

In general, a refinance is always the best option, whether or not you want to exchange equity for cash. In addition to the opportunity to get a lower interest rate, you have also got the ease of having only one mortgage payment to make each month, and although this is a convenience more than anything, it is still an advantage over having multiple bills. Refinancing also offers you by far the largest number of options in terms of how you structure the loan. While the costs of refinancing are higher, those costs are usually offset after three to five years of enjoying your new lower interest rate.

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