How does taking out a mortgage work vs refinancing?

amother

Azalea

Fri, Aug 02 2024, 10:09 am

There are two different things.

Refinancing is a bank evaluating your house and loaning you money based on the value minus 20% (usually.) So if they assess it at 1 million, they would give you a loan for up to $800,000. Then they would pay back your old loan, and minus the closing costs, & if there's anything extra they would send it to you for you to use as you see fit. Sometimes, people will refinance because the mortgage rate has dropped and will only take out the same amount as you already owe (plus closing fees) so that they can pay the original bank, but not have a larger loan than originally. Usually you will get the best interest rate currently available.

A 2nd mortgage, aka a home equity loan is when you take out a smaller loan, maybe because your original mortgage rate is a lot lower than current mortgage rates, based on the increased value of your home. So for example let's say your mortgage balance is 600,000 and your house had gone up in value to 1 mill, they might give you $200,000. This money will go into your bank account to use for whatever you see fit.

Usually these mortgages are not available for longer than 20 years as opposed to 30 and some of them will only do 5 or 10. Because of that the interest rate tends to be higher than the lowest rate available for 30-year mortgages.

So to use a personal example, I have one mortgage for about 700,000 and we needed cash in hand for whatever reason, short term, so we took out a second mortgage since the value of my house has gone up to over 1.5 million. The rate on #1 is less than 3%. Rate on #2 is almost 10%. But our second mortgage will be paid off a lot faster and is a lot smaller.

agreer

Fri, Aug 02 2024, 10:35 am

amother OP wrote:

It sounds like a stupid question but I hear a lot of people say they took out another mortgage on their house to pay for something. What does that mean and how does it work?
Do people do it to remodel their house or do construction?

Yes, people will take out a 2nd mortgage (either Home Equity Loan (HEL) or Home Equity Line of Credit (HELOC)) to remodel or do construction. You can use the funds for whatever you want, including making a wedding or paying for college.

Your first mortgage is based on the value of the house at the time of purchase. However, home values usually increase over time, so your house is worth more now than it was when you purchased it. A HEL or HELOC allows you to tap into the equity without selling your house.

If you have a low interest rate on your first mortgage and a lot of equity, it makes sense to pull out the money via a HEL or HELOC. Then, you'll have two housing payments per month: your regular mortgage, and your HEL/Heloc payment.

However, if the combined mortgage and HEL(OC) payment are more than your current mortgage payment, it doesn't make sense to take out a second mortgage. In that case, you'd probably want to do a cash-out refinance. That is when the bank pays off the first mortgage and restarts you with a new mortgage, which includes the $100,000 you took out to pay for your needed project. Then you will only have one payment per month.