There are times we could all use a little extra money. To buy new furniture. Pay large medical expenses. Or pay off high-interest credit cards.
If you’re a homebuyer or homeowner, there are loans that can help you get “cash out” in just weeks, but which would be best for your pocketbook?
Here’s the Tricky Part
With both a cash-out refinance or a second mortgage, you borrow money from a lender using your home as collateral. Both options are available for VA Home Loans, FHA loans and conventional mortgages. But there are important differences to understand.
- Terms like first mortgage or second mortgage, indicate the lender’s lien position on your title (your home). The lender holding your first mortgage has the first lien on the title and the lender holding the second mortgage would be the second in line.
That means if you don’t make your payments, the debt (your loan) can be liquidated – in other words, the lender forecloses on your home and sells it. The first lien holder would get paid first. The second lien holder would be paid second, and so on.
So What Are the Differences?
A cash-out refinance, available to homeowners, is a brand new loan. The proceeds are used to pay off your existing mortgage, plus you can get cash back. How much cash you can get back will vary by lender and the appraised value of your home.
In today’s market, this might not be an optimal solution to getting cash. For example, if you want $50,000 cash-out and your current loan interest rate is 2.5%, a refinanced loan might give you an interest rate of 6% to 7%. “In that case, you might be better off using a second mortgage to get the $50,000,” says David Lang, a Military Mortgage Advisor in AMS's Chandler, AZ office (Individual NMLS #2023468).
Why? “The borrower in this scenario would have an additional payment for the second loan at a higher rate but the larger balance loan would still be at the lower rate. This would allow them to pay off that balance individually and at some point they’d be back to just paying on the original mortgage,” says Lang.
Refinancing your loan could leave you with a larger monthly payment too. Say you borrow $50,000 out of your equity with a second mortgage, and have a mortgage payment on that loan of about $400 a month. “If you refinance a loan currently at 2% and pay off the first mortgage to get $50,000, you could now have an interest rate of 7% and your payment could increase $1,200 to $1,500 a month,” explains Lang.
“Because the differences are so drastic in this current market, we’re seeing a lot of Members leaning toward a second mortgage.”
Related: What's a Second Mortgage? And Do I Need One?
What You Need to Know About Seconds
When you take out a second mortgage, nothing happens with your existing mortgage.
A second mortgage is a new loan secured by your first (existing) mortgage. But a second loan could strain your budget: You'll continue paying your old loan and now need to pay the monthly payment on the new (second) loan. That’s a big consideration and possibly a drawback for people who have trouble struggling to pay their existing mortgage payment. “Two mortgages will not be easier to pay than one,” Lang says.
“In this current market, a lot of people are leaning toward a second mortgage because it just increases the amount that they're borrowing. So adding $400 or so to their monthly payments lets them consolidate higher-interest debt like credit cards and that can help them out a lot.”
“Plus, mortgage interest can be tax deductible, potentially saving them money depending on how many years they're doing that loan for. (Always consult a tax professional for more information on tax advantages.)
For homebuyers, taking out a second at the same time as their first loan may make sense to boost their down payment to 20%. This lets them avoid paying for private mortgage insurance (PMI), lowering their monthly mortgage payment on the first loan. (Note, VA Home Loans have a funding fee rather than so this situation only applies to other loan types.)
Consult a Mortgage Pro
“There are many factors to consider with these loans and it comes down to choosing what’s right for your personal circumstances,” adds Lang.
Be sure you understand where mortgage rates are now. They hover around:
- 5% to 7% for a first mortgage
- 6% to 9% for a second mortgage, depending on your credit history and how much equity you’ll still have after the loan
- 9% or higher for many credit cards and personal loans, depending on your credit history
Knowing more can help you make the right decision but it’s also good to listen to a pro, says Lang. “Someone who has a loan below the 5% range would be better off with a second mortgage to get money out, while someone with a 5% or higher may be better off refinancing.”
“Understanding these factors can help you make the choice that's right for you,” says Lang.
We’re Here to Help
If you're interested in tapping the equity in your home, be sure you understand what options are available.
An AMS Military Mortgage Advisor like David Lang will be happy to provide you with an honest and fair comparison of your mortgage options, including a wide range of affordable mortgages designed to meet your needs.
Ensuring AAFMAA Members obtain the best mortgage possible is our mission. Get your free mortgage assessment today or give us a call at 844-474-0393.