Cash-Out Refinancing Vs. Second Mortgages

Cash-Out Refinance

Refinancing your home with a cash-out refinance allows you to change the terms of your first mortgage and access the equity in your home. Depending on your loan-to-value (LTV), a cash-out refinance may require a slightly higher interest rate than a rate-and-term refinance. Mortgage investors consider cash-out refinances riskier than purchase money or rate-and-term refinance loans and adjust the interest rates accordingly. If you can significantly lower your the interest rate from your current first mortgage and obtain the cash you require, this is probably the best option.

Fixed rate second mortgages offer stable terms and payments throughout the loan. They do not replace your existing first mortgage but agree to be second in line for payment when the home is sold. If the first mortgage defaults and the home is foreclosed, the second mortgage lender would receive whatever, if anything, is left over, after the home is sold. Fixed rate second mortgages work like installment loans, such as a car loan, where you obtain a fixed amount of funds at closing and once the loan is paid back, it is closed.

HELOCs provide a line of credit using the home as collateral. Normally the interest rates adjust on a regularly scheduled basis. Often, HELOC interest rates are calculated using the Wall Street Journal's Prime Rate. When the prime rate adjusts, so does the loan's interest rate and the corresponding payment. Either the payment may rise or fall depending on what the prime rate does. Most payments are interest only for the initial draw period. Your payments are calculated by multiplying the amount of the loan being used by the interest rate and dividing that figure by 12 (since the interest rate is annual). If you owed $20,000 and had a rate of 5 percent, your annual interest would be $1,250. 1,250 divided by 12 is 104.16.

First mortgages that exceed 80 percent LTV usually require you to obtain mortgage insurance. Second mortgages do not require mortgage insurance. If you are choosing between a cash-out refinance and a second mortgage and your LTV exceeds 80 percent, consider the payment differences between both scenarios.