Cash-out refinance loans and second mortgages both allow you to borrow money while using your home as collateral for the loan. But there are important differences between them to consider when deciding which of the two — if either — is right for you.
Here are three of the biggest differences between a second mortgage and a cash-out refinance loan that are worth considering if you’re thinking about tapping into the equity in your home.
1. Cash-out refinance loans affect your current loan while second mortgages don’t
When you take out a cash-out refinance loan, you use some of the proceeds from it to pay off your current mortgage. That means your existing home loan is eliminated. You borrow more with your cash-out refinance loan than the amount it costs to repay your existing mortgage, though. That’s where the “cash-out” part comes in.
Because you are refinancing your existing loan, your new mortgage will have different terms — including, ideally, a lower interest rate that makes payments more affordable.
On the other hand, when you take out a second mortgage (like a home equity loan), nothing changes with your current loan. You keep paying it as promised and your new loan is entirely separate from your old one.
If your goal is to modify your existing loan terms while getting some cash back, a second mortgage won’t do that for you. But if you’re satisfied with your current mortgage and don’t want to change the payment timeline or interest rate, a second mortgage is a better bet.
2. Cash-out refinance loans leave you with one payment instead of two
If you take a cash-out refinance loan, you will have one new loan you pay each month that both replaced your old mortgage and allowed you to borrow more.
You won’t have to worry about dealing with multiple lenders when you opt for a cash-out refinance loan. However, there’s a chance your new mortgage payment will be larger than your old one in some circumstances. It depends on:
- The interest rate of your new loan versus your old one
- Whether you shortened or lengthened the payoff time
- The amount of equity you took out
If you get a second mortgage, however, you’ll have your old loan to continue paying along with a new loan that also has a monthly payment. Having two payments can make paying your bills more complicated. Plus, it will leave you with a larger monthly obligation since you’ll be adding a second mortgage payment without changing your existing mortgage costs.
3. Second mortgages often have higher interest rates than cash-out refinance loans
Although a second mortgage is a secured loan that typically offers a lower rate than what credit cards or personal loans offer, the primary mortgage holder still has first claim on your house.
This means the second mortgage holder’s claim on the property isn’t quite as secure as when there’s only one mortgage on the home. That’s because the primary lender would have first dibs on the proceeds from a home sale if foreclosure was necessary. So your mortgage rate on a second mortgage will likely be higher than the rate on your first mortgage — and higher than the rate on a cash-out refi.
If you take a cash-out refi loan, you won’t have this issue. You’d have one loan, and that lender would have the primary claim to any proceeds from foreclosing on your home if doing so became necessary. As a result, the rate you’re offered for a cash-out refinance loan will likely be lower than the rate for a second mortgage rate would be.
Consider these big differences between cash-out refinance loans and second mortgages if you’re interested in tapping the equity in your home. Understanding these factors can help you make the choice that’s right for you.
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