Will My Second Mortgage Affect Refinancing?
- When you take out a mortgage the lender places a lien on your home. Lien placements are based on seniority, which means if you payoff your first mortgage your second mortgage assumes first lien position. If you payoff your first mortgage with a new loan that new loan assumes second lien position behind the old second lien that now occupies first position. If you default on your mortgage, the lenders can sell your home to cover the outstanding debt, but the first lien holder receives full payment before the second lien holder receives any sale proceeds. Conventional mortgages normally have low rates that are contingent upon the lien being a first place lien on your home. If your existing second lien lender does not agree to subordinate the existing second lien and allow the new mortgage to move into first lien position, you cannot refinance the first mortgage.
- When you refinance your home you can only borrow up to 80 percent of the value of your home -- if you refinance with a conventional mortgage. This means that if you refinance a home worth $200,000 your mortgage amount cannot exceed $160,000. However, lenders also impose a Combined-Loan-To-Value, CLTV, limit that encompasses the value of all liens on your property. If your lender imposes a CLTV limit of 80 percent and you own a home worth $200,000, then the combined amount of your first and second liens cannot exceed 80 percent. This low overall borrowing limit makes it hard for many people to refinance because they lack sufficient equity.
- Lenders use debt-to-income, DTI, ratios to determine how much you can afford to borrow on a mortgage. The DTI ratio examines your monthly debt expenses as a percentage of your overall income. Many lenders allow borrowers to take out second mortgages with DTI ratios of up to 50 percent. However, DTI limits for conventional mortgages are much tighter and usually capped at 43 percent. Therefore, although your overall debt may remain the same, because of the stricter DTI standards used for first liens, you may not qualify for a refinance if your second mortgage payment causes your DTI ratio to exceed 43 percent.
- Many lenders waive closing costs for second mortgages and home equity loans. If you decide to payoff your second mortgage to refinance your first lien, most lenders require you to pay an early payoff penalty to recoup these costs. Typically, the payoff penalty expires after a number of years, however, you should check with your lender because if the second loan involves substantial penalties those fees could derail your refinance.
