How to refinance when you have a second mortgage

Westend61/Getty Images: Illustration by Issiah Davis/Bankrate

Refinancing a second mortgage — like a home equity loan or home equity line of credit (HELOC) — is a popular way for many to get a lower interest rate. Swapping out a second mortgage for another second mortgage is straightforward, but it can get tricky if you’re refinancing your first and second mortgage together. Let’s break down how refinancing a second mortgage works.

What is a second mortgage?

A second mortgage is simply an additional loan a mortgage-holder takes out, using their home as collateral. The equity you have in your home backs the new loan.

The main thing to know when refinancing a second mortgage — or exploring a refi for your primary mortgage — is that the older loan gets repayment priority. If you default, the lender behind the loan you’ve had longer gets paid back first (e.g., if you sell your house). That pecking order plays a big role when refinancing first and second mortgages.

Types of second mortgages

Here are three types of second mortgages:

• Home equity loan: A home equity loan lets you convert your home equity into a lump sum of money, which you typically pay back with a fixed interest rate over 5 to 30 years.
• Home equity line of credit (HELOCs): A HELOC also converts your equity into money. It is a line of credit that you usually can draw on for 10 years and then pay back over 20 years at a variable interest rate.
• Piggyback mortgage: A piggyback mortgage helps fund a down payment on a house, allowing you to avoid paying for mortgage insurance or taking out a jumbo loan.

5 steps for refinancing your second mortgage

Refinancing a second mortgage is a lot like refinancing any other loan. You’ll need to follow these steps.

1. Check your eligibility. Make sure you have sufficient equity and good enough credit to qualify.
2. Determine your goals. Are you refinancing to lower your monthly payment, secure a lower rate, or something else? The answer will guide your loan search.
3. Compare lenders. Look at the loans offered by different lenders and try to find the best one for your situation. Reading mortgage lender reviews can help you narrow down your search.
4. Apply. Fill out an application and wait to get approved. Be ready to provide financial documents to show your eligibility and to deal with the full lending process, including home appraisals and the like.
5. Avoid applying for other loans. Changes to your credit during underwriting can be a big red flag, so don’t attempt to go after other loans before the refinance is finalized.

Can you refinance a second mortgage?

The good news for borrowers is that you can refinance a second mortgage without too much additional effort. The reason for this is that your second loan is already subordinate to your primary mortgage, so refinancing it doesn’t change the order of priority for lenders who may want to make a claim against your home if you stop making payments.

To refinance just your second mortgage, you’ll need to meet typical mortgage requirements, such as having sufficient equity, good credit and enough income to afford the new loan.

Pros and cons of refinancing your second mortgage

Before refinancing a second mortgage, consider the pros and cons to make sure it’s a good idea.

Can you refinance your primary mortgage when you have a second mortgage?

Yes, it’s possible to refinance your primary mortgage if you have a second loan, but it gets complicated.

Typically, your primary lender has the first claim if you default on your mortgage, with the second mortgage lender having the second claim. If you refinance your primary mortgage, your second mortgage will become the oldest loan against the home, giving the second lender first claim in foreclosing on it.

Most mortgage lenders don’t like that. To refinance your primary mortgage, you’ll usually need to get the second lender to agree to resubordination, ceding the first claim in the event of default to the primary lender again. Some lenders won’t be willing to resubordinate. If they are, it usually means you’ll be paying fees.

And If you want to go this route, before you can refinance your primary mortgage, your mortgage lender must submit a subordination package — all of the documents supporting the request — to the institution holding your home equity loan or line of credit. The second mortgage lender, if they want to go along, typically charges a few hundred dollars to review the package, and approval can take up to six weeks.

Options when resubordination is denied

If your home equity lender says no to resubordination but you still want to refinance, one solution would be to pay off the second loan, if you have the resources or possibly through a cash-out refinance.

However, you must retain at least 20 percent equity in the property after the cash-out refinance or you’ll have to pay private mortgage insurance. That extra cost could put the savings from a refi far away.

Keep in mind that adding extra debt to your refinance may make lenders less keen to underwrite the new loan. That means that your rate may be slightly higher. In fact, many lenders require a loan-to-value ratio of 80 percent for a refinance. That means the amount you borrow can’t exceed 80 percent of your home’s current appraised worth.

Another route is to find a lender who will do a first and second mortgage refinance at the same time. This way you can keep the second mortgage credit line and get a new first. A mortgage broker may be able to assist you with this and other types of refis that involve a second mortgage.

FAQ about refinancing a second mortgage

• How does refinancing a second mortgage impact your credit score?

  Applying for any new loan temporarily lowers your credit score by a few points. However, as you pay down the refinanced loan, your score should improve based on your dropping debt and improving payment history.

• When should you refinance a second mortgage?

  Refinancing a second mortgage can be worth doing in a few scenarios, such as when you can save money overall, reduce your monthly payment or convert from a variable interest rate to a fixed one. It often works best if interest rates have substantially dropped since you took out the loan.

Additional reporting by Kacie Goff