If you want to use your home’s equity to fund an investment project, you’re probably considering a second mortgage or cash-out refinancing.
In this guide, we compare these and discuss their differences, advantages, and drawbacks so you can decide which—if any—is best for you.
How a Second Mortgage Works
When you take out a second mortgage, you’re essentially borrowing against your home’s equity while keeping your current mortgage intact. Second mortgages come in two forms: home equity loans and home equity lines of credit (HELOCs).
A home equity loan gives you a lump sum of money from your property. It’ll have a fixed interest rate and a set repayment term that you’ll need to stick to. Comparably, a HELOC is like a credit line, where you can borrow as much as you need (within your property’s equity), usually with a variable interest rate.
These options require you to commit to an additional monthly payment schedule alongside your primary mortgage.
How a Cash-Out Refinance Works
A cash-out refinance replaces your existing mortgage with a new one for a higher amount; the difference between the two is paid to you in cash. Hard money lenders offer this option and is especially worth considering if you want to get a lower interest rate or extend your loan term.
Since it’s a full refinance, cash-out refinancing usually has higher closing costs than a second mortgage. But you can generally offset this by the savings you’ll make in the long term—if the new loan has better terms.
Comparing Costs and Interest Rates
Fees and interest rates will have a big impact on your long-term spending, so it’s worth comparing these as a priority when you’re choosing between a second mortgage and a refinancing.
Second mortgages have higher interest rates than primary mortgages because lenders are taking on more risk. If you’re edging towards HELOCs, remember that these, in particular, have variable rates that can increase over time.
Cash-out refinances typically have lower interest rates than second mortgages. Still, since you’re refinancing your entire loan, you might pay more interest in the long run if you extend the repayment term.
Which is Best for You?
The right choice for you depends on your specific circumstances.
You might decide that taking out a second mortgage is better if you need a fixed amount or a credit line while still being able to keep your existing mortgage terms (for example, if your first mortgage has a good interest rate and you don’t want to give it up by refinancing).
Cash-out refinancing might also be more cost-effective if interest rates drop before you get your original loan. This financing solution can also make it easier to keep on top of your finances by rolling everything into one payment instead of two separate loans.
Bottom Line
Now that you know the differences between cash-out refinancing and second mortgages, you should be better equipped to decide which one is best for you.
If you’re still unsure, contact a financial advisor who can explain your options in more detail.
