How Is Equity Determined When Refinancing a Second Mortgage?
Your home's equity is a valuable asset. Even if you have a mortgage, home equity can be used as collateral to borrow money at a favorable interest rate. This is called a second mortgage. You may want to take out a second mortgage for various reasons, or refinance your current second mortgage at a better interest rate.
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Home Equity Explained
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Home equity is the amount of money you can sell your house for, less your mortgage and second mortgage. Of course you don't actually know how much you can sell your house for until you do, so assessments by tax authorities and by professional real estate appraisers are used. When they look at your house, they'll look at the age, condition, upgrades, age of the roof shingles, age of the furnace and air conditioner, number of bathrooms and a variety of other factors, including, of course, the infamous "location, location, location."
Second Mortgages
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The amount you can borrow for a second mortgage is almost always less than the value of your home equity. The lender wants to ensure you don't have any property taxes or utility bills outstanding. They'll also look at your credit history, and your income. They also want to know why you want the money. Most lenders also have maximums expressed as a percentage of the property value. For example, they may have a policy only using 80 percent of a home's value for loan purposes. In this example, if your home is appraised at $200,000, then the value of the first and second mortgage combined could not exceed $160,000.
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Line of Credit
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Sometimes a second mortgage is set up as a line up of credit. This means that you can borrow any amount up to your approved limit, either in one lump sum or as a series of small advances. For example, if you have a homeowner's line of credit of $50,000 you can immediately borrow $25,000. Later, if you pay all of the interest, you may want to borrow another $15,000. This still leaves $10,000 for you to borrow at a later date. When you pay off the line of credit, you can borrow the full $50,000 again without having to go through the application process.
Uses
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Sometimes people get a second mortgage because they can't borrow enough with the first mortgage to purchase the home that they desire. In this case it may be advantageous to refinance the second mortgage when the price of the house has risen (as you will have more equity), when interest rates have fallen or if your income is higher. Any of these conditions may make you eligible for a lower rate, in which case re-financing may make sense. A re-finance may involve fees, including legal fee and appraisal fees, but if the rate is low enough the transaction can still be worthwhile.
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References
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