A second lien is also known as a second mortgage. It is different from refinance in that your mortgage arrangements remain constant, but you pay an extra monthly repayment for the loan. A second lien and second mortgage are fundamentally the same, and are based upon the equity of your home.
Real Estate Equity
Real estate equity is the difference between the current value of your home and what you still owe on it. Let’s say you purchased your home with a $400,000 mortgage and have repaid $150,000 of that capital sum. Your home has been valued at $750,000. Your equity will be $500,000 (work it out.) If you need cash for extensive repairs or improvements, or even to buy a new boat, you can raise some on your home. Your equity is $500,000 so you can raise a good proportion of that as a second lien – or second mortgage. These terms mean the same thing. You could also use your equity to refinance your mortgage. This means scrubbing your existing mortgage and taking a new one based upon what you currently owe. You can extend your repayment period and reduce your monthly repayments. Some people find this an attractive option, particularly if they are beginning to struggle with the existing monthly repayments.
They have a lot of equity (500,000) but are still paying for their original $400,000 mortgage! It makes sense to them to refinance the mortgage as they are paying less. However, is this a good decision, and would they be better off by refinancing the existing mortgage or taking a second lien on their home to fund the improvements (or vacations!)? If you refinance your mortgage, you will have high closing costs and have to pay private mortgage premium costs on your mortgage. Loan approval can take some time, and the entire process can be lengthy and stressful. This is not your first mortgage, remember, when you were excited and looking forward to owning your first home. This time round you do not want it to be a long, drawn out affair.
Second Lien Advantages
A second lien or second mortgage (same things) is significantly quicker to arrange. You keep paying your existing mortgage repayments, but also pay for the second mortgage each month. If you are confident of meeting both payments, then this is the way to go. However, keep in mind that if you fail to maintain either set of payments then you could lose your home. However, if you take this path then you will save on private mortgage insurance and your tax deduction will also be more attractive. Not just that, but you will be able to avoid escrow payments if you want and your equity will increase at a faster rate. Equity is always good to have when times get bad!
Which is Best?
So which is best for you when you want extra cash to carry out home improvements or pay your kids’ college fees? A second mortgage or refinance your home? The balance seems to lie with the second mortgage, but keep in mind the big negative! You could lose your home by failing to make the payments. That said, the second lien seems just to swing it – but the choice is 100% yours.