Refinancing First and Second Mortgages

Mortgage refinancing is big business for American banks and mortgage companies. If you own a house, you've probably been approached by one of these institutions with offers to refinance your first or second mortgage. But do you understand what refinancing is all about? Are you confused as to whether or not refinancing is a good option for you? The purpose of this article is to present the home buying tips and facts about mortgage refinancing in terms that are as simple as possible, thereby enabling the homeowner to decide whether or not refinancing is a sensible option.

Reasons to Consider Refinancing

Whether you're considering refinancing first or second mortgages, the reason most often cited is a desire to reduce interest rates and monthly payments. A homeowner, whose original mortgage was established at 8% five years ago, could see a significant reduction in monthly payments and total amount paid if he could refinance his mortgage at a rate of 6%. Where the monthly payments are concerned, refinancing could make the difference in whether or not the homeowner can afford to continue owning his house.

First and Second Mortgages Defined

Before discussing refinancing a first or second mortgage, it's important that we define each one. The first mortgage is the principle mortgage on a house. It's called a first mortgage due to the fact that the mortgage lender is the first in line to be paid if the borrower defaults. Typically the first mortgage is the one that is obtained when the house is first purchased.

A second mortgage is one whose lender is second in line in case of default. It can be obtained at the time of purchase as a loan to cover closing costs and down payment. More typically however, a second mortgage is obtained sometime after the home's purchase in order to provide the home owner additional cash for a variety of reasons. Second mortgages can be established as home equity lines of credit or lump sum cash loans.

Typically a second mortgage cannot be obtained in an amount that is higher than the difference between the home's market value and the balance of the first mortgage, otherwise known as the home's equity. In other words, if the balance due on the first mortgage is $80,000 and the home's market value is $100,000, a second mortgage typically will not be able to exceed that $20,000 difference. There are exceptions to this rule but they're not the norm.

Refinancing a First Mortgage

Refinancing a first mortgage is a straightforward process that usually contains no hitches. It's no different than when you obtained the mortgage initially, in terms of process and what the lender is looking for. In most cases there will be closing costs involved and points paid, just as with the initial mortgage. Refinancing a first mortgage should be done within three to ten years of home purchase in order to make it worth the cost.

The home owner who has two or more mortgages will most likely be unable to obtain refinancing of the first mortgage. It is possible however, to combine first and second mortgages together in a refinancing package. This works out rather well if the home has appreciated in value since the two mortgages were first take it out. In such cases the assessed value of a home will be greater than the two mortgages combined, and a bank will be more than willing to combine the two into a single loan. This type of combination refinancing is a great way to reduce the interest rate on two higher mortgages.

On the other hand, if the home has depreciated or remained flat, combining first and second mortgages into a single loan will pose a risk to the homeowner; and that's if he can find a bank or mortgage lender willing to accept the deal. With combination refinancing it's very easy for the homeowner to find himself under water, meaning that he'll owe more on his mortgage than the home is worth. If your bank suspects that you may find yourself underwater anytime in the future, they're not likely to approve you for a refinancing package.

Refinancing a First Mortgage versus Taking a Second

During times of financial distress it's common for homeowners to look for any means of raising cash, including taking a second mortgage. But this is not always the wisest course of action. Financial stability requires disciplined control of one's debt and spending habits. Proper discipline suggests we think twice before obtaining a second mortgage.

For example, let's say a home owner decides to acquire a second mortgage in the form of a home equity line of credit. That credit will almost always have an interest rate several percentage points above that of the first mortgage. In many cases, that rate is double that of the first mortgage. If there's another way to provide the cash the home owner needs, without paying such exorbitant interest, that's something the homeowner should look at very seriously.

If he can refinance his first mortgage at one or two percentage points less than what he currently pays, the savings in his monthly payment may provide the extra cash that he needs. That cash may not be immediate, but accumulated over several months of mortgage payments, it can add up. With proper planning and financial discipline, it is possible in most cases to weather the financial storm until the savings from a refinanced mortgage can provide the cash a home owner is looking for.

Regardless of whether or not refinancing a first mortgage can meet the financial needs of the distressed homeowner, refinancing a second mortgage will be out of the question for most people. The second mortgage is already at a very high interest rate, and it's already been taken out against the equity value of the home. Even if a homeowner could find a lender willing to consider it, the interest rate probably would be prohibitive. In most cases the wisest move is just to avoid a second mortgage if it all possible.

Refinancing makes good sense when homeowners need to reduce their monthly payments and interest paid on a home loan. It's not difficult to do, and the process will be nearly identical to what you experienced when the mortgage was first obtained. Under the right conditions, refinancing a first mortgage is a win-win for both lender and borrower.