Second Mortgage versus Refinancing

How do you know when it is more advantageous to refinancing and when it is better to get a second mortgage home loan? The answer isn’t always as obvious as it may first seem.

The rule of thumb has always been to refinance your first mortgage if interest rates drop one percentage point or more and you plan to live in the house for at least three more years. The reason for the three more years rule is because of the fees involved in refinancing. Even with a lower interest rate and lower monthly payments, it will take as long as three years to pay off the fees involved in refinancing. Once the fees are paid, however, the savings from refinancing really begin to quickly accumulate.

In general the rule of thumb has been that if interest rates haven’t dropped any, then you are better off leaving your first mortgage untouched and taking out a second mortgage. While both of those rules of thumb have some validity, they don’t take all the variables into consideration.

For example, if you have any blemishes on your credit record, especially recent black marks, then refinancing a first mortgage may prove to be a lot more difficult and time-consuming that you thought and you could be turned down entirely or you may have to pay a higher rate of interest than you counted on, making a refinanced first mortgage less attractive than a second mortgage even if interest rates have dropped.

Also keep in mind that when you refinance a first mortgage you are required to pay virtually the same closing fees that you had to pay when you originally got your first mortgage. In essence, these fees increase the interest rate on the loan, sometimes making the true rate of refinancing very close to the rate charged for a second mortgage.

Since second mortgages are subordinate to a first mortgage, the interest on a second mortgage is always higher than the interest for a new first mortgage. This means that should you default on your loan, the first mortgage will be paid first and the second mortgage will only be paid should there be remaining funds.

However, as we have noted, the added fees that one must pay to refinance a first mortgage may actually close the interest rate gap between a refinanced loan and a second mortgage by a much greater margin than initially anticipated.

Getting a second mortgage requires a lot less paperwork than refinancing a first mortgage, and your credit problems and even your income are not as important when you apply for a second mortgage.

For all of these reasons, it is often simpler and almost as inexpensive to take out a second mortgage or an equity line of credit than it is to refinance a first mortgage even with a lower interest rate on the new first mortgage.