HELOC, Refinancing, and Second Mortgages: Understanding Your Options
If you are looking to lower the cost of your mortgage, or to access cash that is currently tied up in your equity, you may want to consider taking out a loan against your home equity. There are a number of different ways you can go about this, but the three most popular approaches are refinancing, taking on a second mortgage, and getting a home equity line of credit (HELOC).
Home Equity Line of Credit (HELOC)
A home equity line of credit, or HELOC, is a type of secured loan. You can use it to withdraw money whenever you need to, up to a set credit limit. Unlike the other loan options, HELOCs do not function as a lump sum but rather as a revolving line of credit, similar to a credit card.
You can use the funds from your HELOC throughout the draw period, which lasts an average of ten years, even as you are repaying the loan. Furthermore, you won't be required to pay back any principal during the draw period; only the interest. Once the draw term ends however, you must make regular payments on both the interest and principal.
You can borrow between 65% and 80% of the appraised value of your home with a HELOC. This means that you can obtain a HELOC with just 20% equity. Even if you are approved for a large HELOC loan, you will only be charged interest on the amount that you pull out and use, not on the full amount you qualify for. Most lenders will not approve you for a HELOC if your credit score is under 650, but some alternative lenders may be able to help you at higher rates.
Refinancing Your Mortgage
When you refinance your mortgage, you are taking out a new mortgage to replace your old one. Through refinancing, you may be able to secure a larger loan amount, better terms, lower interest rates, and a shorter amortization period. Refinancing your mortgage also allows you to free up the equity you already have in your home and repurpose it.
If you want to use your refinance to generate cash, all you need to do is to replace your current mortgage with one of a higher value. Then, you can deposit the difference into your savings account. If your credit score or income has improved since you applied for your first mortgage, you may also be able to qualify for better rates and terms, lowering your interest costs in the long run.
A second mortgage is another type of loan that you can consider. It allows you to borrow up to 75% to 80% of the value of your home, using the equity in your home as collateral. In contrast to refinancing, you are not replacing your current mortgage with a new one. Instead, you are taking out a loan that you will then pay back alongside your existing mortgage. This of course depends on factors such as location, condition of the property, and more.
In order to qualify for a second mortgage, you must hold at least 20% equity in your home, and ensure your credit score is in good shape. Some lenders will grant you a second mortgage even with a credit score under 600, but your interest rates will likely be higher. On top of the additional interest fees you will incur, there are a few other costs to consider before taking on a second mortgage. Ensure you have enough cash to cover appraisal, lender, and legal fees.
Pros and Cons
While HELOCs, second mortgages, and refinancing are all great options, they each have their own advantages and disadvantages. It is important to weigh both the pros and cons of each option before making a decision.
HELOCs: Pros and Cons
A HELOC is a great option if you are not yet sure how much cash you will need. Because a HELOC operates as a revolving line of credit, you only pay interest on the amount you actually use. This makes the HELOC a very flexible option that will not penalize you for not using the full loan amount.
On the other hand, you will likely have to take on higher interest rates if you open a HELOC. Setting up a HELOC requires you to refinance or renew your mortgage, and the new interest rates you will be granted can be significantly higher than your original terms.
Refinancing Your Mortgage: Pros and Cons
Refinancing your mortgage can come with many advantages. If your credit score, income, or debts have improved since you first applied for a mortgage, you may be able to lower your rates and negotiate better terms, saving you thousands in the long run.
Additionally, you may be able to decrease your amortization period, thereby paying off your mortgage faster than if you were to take on a new mortgage.
The main drawback to refinancing your mortgage is that you will have to start paying interest immediately. Additionally, most lenders will issue a prepayment fee if you break your original mortgage before the end of its term. It is important to account for these fees in your calculations.
Second Mortgage: Pros and Cons
The good news about second mortgages is that they are far easier to qualify for than a refinanced mortgage. If you are looking to avoid hassle, a second mortgage may be the right option for you.
Unfortunately, second mortgages do have notoriously high interest rates. These rates are higher than those of a HELOC or a refinanced mortgage, but are lower than credit card interest rates. For this reason, second mortgages are still a great option if you are looking to consolidate debt.
Of the three methods, a second mortgage will be the priciest choice overall. If you are not able to manage those additional costs, you run the risk of losing your home.
How to Choose the Right Option for You
While all HELOCs, second mortgages, and refinanced mortgages can all be great ways to free up equity, you may be having trouble deciding which one to choose. Depending on your circumstances, you may find that some techniques are more helpful to you than others.
If your financial situation has improved, your credit score has increased, or market interest rates have dropped, you may want to consider refinancing your mortgage. While refinanced mortgages are harder to qualify for than second mortgages, they are often the cheapest way to turn your equity into a lump sum loan. If your credit or income has improved, you can likely negotiate excellent terms and rates with your lender.
If your financial situation has worsened since applying for your original mortgage, refinancing your mortgage might not be the best fit for you. Likewise, if you are looking for a loan-to-value ratio higher than 80%, you may want to consider other loan types and options.
Unlike a refinanced mortgage, a second mortgage can present a loan-to-value ratio of up to 80% in may cases. Furthermore, it is much easier to qualify for a second mortgage than for other types of loans. Taking on a second mortgage comes with few barriers to entry but costly interest rates, making it a great option for homeowners currently going through a rough patch who expect to have their finances improve or return to normal in the near future.
A second mortgage could also be the right choice if you are looking to renovate your property. Many homeowners take out a second mortgage, invest the money into home renovations that raise the value of the property, and then sell the home for a profit— paying off both mortgage loans.
If you are unsure of how much money you will need, taking out a HELOC may be the best choice. Refinanced mortgages and second mortgages both require you to pay interest on a lump sum. With a HELOC, you only pay interest on the amount you spend, making it a much more flexible loan. If you are looking to protect yourself against unpredictable expenses, a HELOC is often the perfect choice.
Regardless of what you choose, Clover Mortgage is here to help. Our experienced team of brokers will work with you to determine the perfect type of loan, and connect you to the perfect product out of our network of 50 lenders. Contact Clover Mortgage today to schedule a free consultation with one of our professional brokers and begin freeing up the equity in your home!