It’s time to do something about the mortgage, but you’re not sure which path to take. A complete refinance may lower the interest rate and payment amount. A second mortgage would give you enough to consolidate credit card debt, lowering the payment amount and interest rate while leaving the current mortgage on its own schedule. Which way is best? Choosing between a refinance or second mortgage could save you thousands of dollars.
An overall refinancing strategy may be advantageous when mortgage interest rates sink. If the homeowner has a variable rate mortgage or a higher fixed rate loan, this is a chance to permanently lock in a new, lower current rate for the life of the loan. If cashing out home equity by increasing the loan size for home improvements, a refinance may make sense because these improvements increase the value of the home over the long term, helping justify the longer length of time it takes to repay most mortgage refinances. For other, short-term needs, a second mortgage--often called a home equity loan--allows the homeowner to continue paying on the original primary loan while still achieving a lower interest rate than most consumer debt options.
Both a second mortgage and refinance are tax-deductible, but a mortgage refinance may include deductible costs, such as points and mortgage fees. Although difficult, the homeowner should compare total savings between new payment amounts, amounts saved on any other debts retired with proceeds and differences in deductible expenses before subtracting the costs to refinance.
A second mortgage is generally 10 or 15 years in term. A refinance may lengthen the mortgage by 15 or 30 years, unless the homeowner pursues a non-conventional time frame or a rate-and-term mortgage, which continues the current mortgage without increasing its length or altering the current amortization schedule. These non-conventional mortgages are hard for firms to package into securities and are therefore difficult for homeowners to secure. Homeowners looking for small amounts of money may find a second mortgage at a lower cost and quicker time frame than a complete refinance.
Although fees range widely, refinance costs can be $2,000 to $3,000 higher than a second mortgage. The second mortgage, however, usually has a variable interest rate which could cost the homeowner more in a rising interest rate environment. Homeowners should ask lenders about prepayment penalties, points, escrow fees, title insurance, application fees, credit report fees and other costs added by a broker or bank. Homeowners should receive a truth-in-lending statement detailing all loan fees before applying.
Financial guru Dave Ramsey and others warn about turning short-term credit card debt into a long-term liability. When paying off credit cards with a second mortgage or refinance, homeowners still haven’t attacked the roots of a credit card problem and risk running up the credit cards again while inflating the mortgage. Without a solid debt reduction strategy, a refinance could be doomed from the beginning.
- Journal of Financial and Strategic Decisions: Evaluating Refinancing Opportunities Precisely (PDF)
- Say Educate: 4 Strategies for Smart Mortgage Refinancing
- "The Total Money Makeover, a Proven Plan For Financial Fitness;" Dave Ramsey; 2008
- Bankrate: Refinance vs. Home Equity Loans
As a former financial advisor to companies and individuals for 16 years, Joe Andrews knows financial planning and marketing from start-ups to personal budgets. He also writes on motor racing, board games and travel. Andrews received his B.A. from Michigan State University in English. He is currently working on a young adult novel.