As a homeowner, you have two main options to take cash out of your property: refinancing or obtaining a second mortgage. While both options allow you to access your home equity, they come with different requirements, costs, and payouts. The question is: How do you know which one is right for you?

What Is a Second Mortgage?

Also known as a junior lien, a second mortgage is essentially another loan on the home. The homeowner borrows against their equity — or the amount of ownership they have paid into the home — to secure the loan. While a second mortgage comes with a higher interest rate and separate payment schedule from the primary mortgage, it’s typically cheaper than borrowing money through a credit card or personal loan.

There are two types of second mortgages: a home equity line of credit and a home equity loan. Both types of loans come with requirements that you need to meet in order to qualify, as well as possible closing costs — though your lender may cover some of these fees. Not all lenders offer second mortgages, so be sure to check with yours before moving forward.

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How Does a Second Mortgage Work?

Homeowners with a second mortgage can borrow up to 85% of their total equity, depending on the lender. Equity is the difference between the fair market value of the home and the outstanding amount on the mortgage. You build equity as you make monthly payments and reduce your mortgage balance. When you’ve paid off the principal, you’ll have 100% equity — and no more mortgage.

Second mortgages work similarly to regular mortgages in terms of loan application and repayment. Lenders have specific credit, equity, and income requirements that borrowers must meet to get approved. The second mortgage has its own interest rate and an amortization schedule separate from the first loan, meaning that borrowers make two monthly mortgage payments — one for each loan.  

What differentiates a second mortgage from a primary mortgage how repayment is prioritized if the borrower fails to pay off their debt. Because the home serves as collateral, lenders can sell it to recoup any losses. In these cases, the primary mortgage will be repaid first. Then, if there’s any money left over, the second mortgage will be repaid next, with the responsibility for any remaining debt falling to the former homeowner.

This is why a second mortgage is sometimes referred to as a junior lien. The first mortgage is secured with the same asset and prioritized when the collateral is being used to recover losses.

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What Are the Types of Second Mortgages?

There are two types of second mortgages: the home equity line of credit and the home equity loan. Each comes with its own borrowing, payout, and repayment processes, so be sure to familiarize yourself with them before making a decision.

Home equity line of credit

A home equity line of credit, commonly referred to as a HELOC, allows for continuous withdrawal on the equity in your home for a specified period and up to a certain limit, much like a credit card.

There are two phases to a HELOC: the draw and repayment periods. During the draw period, which may last from five to 10 years, you can borrow money from the line of credit. You also make minimum payments during this time. Once the draw period ends and the repayment period begins, you’re no longer allowed to borrow money, and you must pay off the balance you’ve accumulated plus interest.

HELOCs typically come with variable interest rates, which means that the rate on the account may change during the draw and repayment periods.

Unique features of a HELOC include:

  • The homeowner can borrow money over a period of time.
  • Payments are typically based on a variable interest rate.
  • Borrowers may be required to pay off the balance in full at the end of the draw period, or allowed to repay the debt in installments.

Home equity loan

A home equity loan is a lump sum that you borrow against the equity in your property. The money is paid out once, and repaid in fixed monthly installments — just like your original mortgage.

Unlike a HELOC, the repayment period for a home equity loan begins as soon as you take out the loan. Additionally, interest rates on home equity loans tend to be fixed, which is an important factor to consider when deciding between a HELOC and a home equity loan.

Unique features of a home equity loan include:

  • The borrower receives a lump-sum payout.
  • Generally, the loan has a fixed interest rate.
  • The repayment period on a home equity loan starts immediately.

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Second Mortgage Requirements

Like your primary mortgage, secondary mortgages come with certain requirements that help assure the lender of your ability to pay back the loan. These requirements include:

  • Credit score: The minimum credit score for a second mortgage is generally around 620, though a higher score may help you get a better interest rate on the loan.
  • Proof of income: Lenders will likely ask for recent pay stubs and proof of employment so that they know you can make regular payments.
  • Equity: Lenders want you to have at least 15% to 20% equity in your home before you take out a second mortgage. Also, the more equity you have, the more cash you may access.
  • Debt-to-income ratio: This is the proportion of your monthly debt payments to your gross monthly income. Lenders typically want to see a DTI of less than 43%.

Different lenders may have varying requirements for second mortgages, so be sure to double-check your eligibility and put yourself in the best possible financial position before moving forward.

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Pros and Cons of Second Mortgages

While obtaining a second mortgage gives you the option to leverage your home’s equity, it can also come with drawbacks. Check out some pros and cons of taking out a second mortgage.

Pros of taking out a second mortgage

There are several benefits of taking out a second mortgage, including:

  • A lower interest rate compared with a personal loan or credit card.
  • Freeing up equity to fund home improvement projects or pay off other debts.
  • With a HELOC, you have flexibility in how much you withdraw as well as a delayed repayment period.
  • With a home equity loan, you can access your funds immediately, and the interest rate is fixed.

Cons of taking out a second mortgage

Some drawbacks to getting a second mortgage include:

  • Greater risk of losing your home if you can’t keep up with payments on both mortgages.
  • Higher interest rates on second mortgages compared with primary mortgages.
  • With HELOCs, you have an adjustable interest rate that can spike during the repayment period, and you may be required to pay off the balance all at once.
  • With a home equity loan, you might take out more than you need, and the repayment period starts immediately.

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When You Should Consider Taking Out a Second Mortgage

Getting a second mortgage is a serious financial decision that shouldn’t be taken lightly. A second mortgage can put your home at risk if you aren’t able to make payments, and could be more expensive than your primary mortgage due to higher interest rates. However, second mortgages also offer borrowers the chance to pay down other debts or reinvest in their home through improvements and renovations.

While borrowers should review their personal situation and consider consulting with their lender and a financial advisor before making any moves, here are some scenarios when taking out a second mortgage might make sense:

  • You want to keep the terms of your primary mortgage. If your primary mortgage has a low interest rate, getting a second mortgage allows you to preserve those terms while accessing your home’s equity.
  • You want flexibility. With a HELOC, you can take out only as much as you need, so you won’t be stuck with an unnecessarily large loan if a home improvement project ends up costing less than you expected.
  • You don’t want to pay too much in closing costs. A second mortgage can be cheaper than a refinance in terms of closing costs — while offering similar access to your home’s equity.

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What Is Mortgage Refinancing?

Mortgage refinancing is when you replace your existing home loan to get a lower interest rate, change your loan term, access the equity you’ve built in your home, or accomplish a different financial goal. Two of the most common types of mortgage refinancing are rate-and-term refinances and cash-out refinances.

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How Does Refinancing Work?

Refinancing allows the borrower to replace their current mortgage with a new one, typically with more-favorable terms such as a better interest rate or lower monthly payments. However, closing costs for a refinance run typically 2% to 3% of the loan amount and can be higher compared with a second mortgage. To refinance, borrowers must meet specific requirements in terms of credit, income, and equity needed, though these requirements may differ based on the lender.

A key point of refinancing is that the borrower is changing the terms of their loan while maintaining only one lien on their home. This means they are responsible for just one monthly payment to a lender.

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What Are the Types of Refinances?

There are several types of refinances available to qualified borrowers, but we’ll focus on cash-out refinances and rate-and-term refinances. Both types allow borrowers to change their loan terms, though only cash-out refinances give access to home equity.

Cash-out refinance

A cash-out refinance replaces a borrower’s current mortgage with a new one that has a higher principal balance. The borrower may use the difference in cash as they see fit. Depending on individual lender limits, borrowers can take out up to 80% of the equity in their home.

Here’s an example: Say you have a house worth $100,000 with a mortgage you’ve paid down to $60,000. That means you have 40% equity, or $40,000. If you want to withdraw $10,000 of that equity, you could refinance to a $70,000 mortgage, which would be the $60,000 you still owe plus the $10,000 you want to take out. You’d receive a new interest rate, a new payment schedule, and $10,000 in cash.  

Cash-out refinances can be an appealing way to access equity if market interest rates are low. However, if you need the money when interest rates are high, you might get stuck with a higher rate than before.

Rate-and-term refinance

A rate-and-term refinance is when a borrower replaces their old mortgage with a new one that has a different interest rate, loan term, or both. This doesn’t affect the amount of equity in the home.

With a rate-and-term refinance, you have the opportunity to save money through a lower interest rate or manage your monthly payments differently. For example, if you’re having trouble making payments on a 15-year mortgage, you could extend the loan term to 30 years and lower your monthly payments. Keep in mind that increasing your loan term might mean paying more interest over time. Alternatively, you could pay off your home faster by switching to a shorter loan term with higher monthly payments.

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Mortgage Refinancing Requirements

Like applying for any loan, refinancing comes with certain requirements. While these can differ depending on the lender and loan type, here are some general criteria you’ll likely have to meet:

  • Credit score: In general, conventional loans require a credit score of 620 or higher before you can refinance. Government-backed loans may have lower thresholds. However, the higher your credit score, the lower the interest rate you can typically get.
  • Proof of income: Lenders need proof of employment and income before approving you for a refinance.
  • Equity: Lenders want to see that you have at least 20% equity in your home. With cash-out refinances, your equity helps determine how much cash you can access.
  • Debt-to-income ratio: Lenders require a DTI of 50% or lower before you can refinance.
  • Seasoning requirement: Some cash-out refinances have a seasoning requirement, which means there’s a waiting period between when you purchased the home and when you’re allowed to refinance. For conventional loans, this period is six months.
  • Closing costs: You need to pay upfront fees for an appraisal, underwriting, and other services when you refinance.

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Pros and Cons of Refinancing

While mortgage refinancing can help you secure a lower interest rate, manage your monthly payments, and access your home equity, it also has certain drawbacks. Here are the pros and cons to refinancing.

Pros of refinancing your mortgage

The benefits of refinancing your mortgage include:

  • Getting a better interest rate when market rates drop.
  • The option to access your home equity or adjust your loan term and monthly payment.
  • Making only one monthly loan payment as opposed to two with a second mortgage.

Cons of refinancing your mortgage

The drawbacks to refinancing your mortgage include:

  • Having to cover higher closing costs compared with a second mortgage.
  • Paying more in total interest if you extend your loan term.
  • Losing a good interest rate if you refinance at the wrong time.

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When You Should Consider Refinancing Your Mortgage

There are times when it makes sense to refinance instead of taking out a second mortgage. These situations include:

  • You prefer streamlined monthly payments. Since refinancing replaces your original mortgage, you’ll make only one monthly payment. With a second mortgage, you would have to make two payments.
  • You want to change your mortgage terms. If you want to adjust your loan term or score a lower interest rate, then refinancing can help you achieve those goals. Taking out a second mortgage means you would still be responsible for your current loan.
  • Interest rates are low. If market rates are hitting rock bottom, it might be a better idea to refinance your mortgage and see if you qualify for a lower interest rate.
  • You’re prepared to pay closing costs. When compared to a second mortgage, paying higher closing costs on a refinance in exchange for a lower interest rate might save you more money in the long run.

Whether a refinance is right for you will depend on your lender, your financial situation, and other factors, so be sure to do your research before choosing one option over the other.

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Second Mortgage vs. Refinance

Second mortgages and refinances both allow access to equity and offer a cash-out option, but their requirements, payouts, and repayment terms can differ. Below is a table to illustrate the main differences between the two:

The Differences Between Getting a Second Mortgage and Refinancing

Home equity line of credit– Minimum credit score of 620
– 20% equity or more
– DTI of 43% or less
– Variable interest rate
– Potential closing costs
– A draw period of five to 10 years with a flexible payout structure– Minimum payments required during the draw period
– Pay off the balance payment in full after the draw period ends, or make monthly payments on top of payments for the primary mortgage
Home equity loan– Minimum credit score of 620
– 20% equity or more
– DTI of 43% or less
– Fixed interest rate
– Potential closing costs
– A lump-sum payment
– A monthly payment on top of the primary mortgage payment
Cash-out refinance– Minimum credit score of 620
– 20% equity or more
– DTI of 50% or less
– At least six months between loans
– Interest
– Closing costs
– A lump-sum payment– A single monthly payment
Rate-and-term refinance– Minimum credit score of 620
– 20% equity or more
– DTI of 50% or less
– Interest
– Closing costs
– None– A single monthly payment

These requirements aren’t universal, so make sure to check with your lender about how to qualify for a refinance or a second mortgage.

Similarities between taking out a second mortgage and refinancing

Second mortgages and refinances share several key features:

  • You’re required to meet certain credit, equity, and income requirements to qualify for a second mortgage or refinance.
  • With a refinanced loan or second mortgage, you must repay all the equity you’ve borrowed, along with any interest that has accumulated.
  • If you qualify, cash-out refinances, HELOCs, and home equity loans allow you to draw on the equity in your home.
  • Cash-out refinances and home equity loans offer equity in a lump-sum payment.

Differences between taking out a second mortgage and refinancing

There are several key areas where refinances, home equity loans, and HELOCs diverge from one another:

  • A second mortgage doesn’t give you the option to change your original loan term or interest rate, while a refinance can allow you to do so.
  • Second mortgages typically come with higher interest rates and lower closing costs than a refinance.
  • Second mortgages require you to make two separate monthly payments, while refinances simply replace the old mortgage payment with a new one.
  • HELOCs offer a continuous draw period, whereas cash-out refinances do not.

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How To Decide Between a Second Mortgage and Refinance

When it comes to choosing between a second mortgage or a refinance, approaching the decision from different angles is crucial.

“It is a good idea to take out a second mortgage rather than refinance when your first mortgage rate is so low that it would benefit you to keep that existing mortgage rate in place,” says Leisa Peterson, a certified financial planner and business strategist at WealthClinic in Sedona, Arizona. “On the other hand, refinancing is a good idea if you can save money both monthlyandover the lifetime of the loan compared to the loan you have currently.”

Here are a few factors to consider as you’re deciding between a second mortgage and a refinance:

  • Current finances: If you don’t have a lot of cash to pay upfront for closing costs, then getting a second mortgage might make more sense. Keep in mind, though, that you’ll probably end up paying more in total interest.
  • Monthly payments: A second mortgage means making two payments per month. A refinance, on the other hand, can help you lower your monthly payments by increasing your loan term — at the expense of paying more interest overall.
  • Payout: If you’re unsure about how much money you need, and you don’t want to risk borrowing too much, then choosing a HELOC might make sense. It can give you a more flexible payout structure and allows you to take out only as much as you need.
  • Market rates: If interest rates have dropped since you took out your mortgage, then refinancing might be able to help you snag a better rate. On the other hand, if interest rates are high, you can keep the rate on your primary mortgage by taking out a second mortgage instead.
  • Credit score: If you’re qualified, a good credit score can help get you a lower interest rate. So, if you’ve boosted your score since taking out your mortgage, a refinance might offer you a better rate than your original loan.

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The Bottom Line on Taking Out a Second Mortgage vs. Refinancing

Second mortgages and refinances can offer access to the equity in your home, allowing you to pay off existing debts, renovate your home, or invest in other endeavors. Second mortgages may offer lower closing costs, flexible payouts, and the ability to keep your original loan terms, while refinances replace your old mortgage with a new loan and generally come with higher closing costs as well as lower interest rates. Deciding between the two options will take plenty of consideration and also affect your financial future — so choose wisely.