You have equity in a property and you want to use it. There are two structures, they behave very differently, and the right answer depends almost entirely on the loan you already have. Here is how to choose.
The two structures
A cash-out refinance replaces your existing first mortgage with a new, larger one. The new loan pays off the old one and the difference comes to you. One loan, one payment, one set of terms, and the old loan is gone. See cash-out refinance.
A second mortgage leaves the existing first exactly as it is and records a new loan behind it. Two loans, two payments, two maturities, and the original terms survive. See how a business purpose second mortgage works.
Everything else follows from that difference.
What a refinance actually costs
The rate on the new money is only part of it. The real cost is what happens to the debt you already had.
If your existing first carries terms you would not obtain today, a cash-out refinance reprices your entire balance to get at the equity. That can be far more expensive than a higher rate on the new money alone, and the difference is invisible if you compare rate to rate.
There is also the transaction itself: a full underwriting, a valuation, title, escrow and origination on the whole loan amount rather than on the new portion. And there may be a prepayment penalty on the loan you are replacing, which is a real cost of the decision.
Against that, a refinance gives you one loan, one payment and one maturity. Simplicity has genuine value, particularly on a property you intend to hold for a long time.
What a second actually costs
A higher rate on the new money, because a second lien is repaid after the first and the same equity protects it less. Our post on lien position and CLTV explains why that ranking sets the price.
Against that, the existing first is untouched, the transaction is smaller because only the new money is being underwritten and priced, and there is no prepayment exposure on the original loan.
You do take on a second payment and a second maturity. On a short-term business purpose second, that maturity is the thing to plan around from the day you sign.
The five questions that decide it
What terms does the existing first carry? The most important question by some distance. A first you would not get again is worth protecting, and a second protects it. A first with unremarkable terms is a candidate for replacement.
How long will you hold the property? A long hold favors consolidating into one clean loan. A short hold, where you expect to sell or refinance within a couple of years anyway, favors a second, because you are not paying to restructure debt you are about to retire.
How much do you need, and for how long? A modest amount for a defined project with its own proceeds is a natural second. A large amount that changes the whole capital structure is a refinance question.
What is the combined leverage? Add the first mortgage balance to the new money and divide by the value. Our bridge program publishes LTV up to 80%, with up to 75% LTV on cash-out, which tells you that cash-out transactions are underwritten more conservatively than purchases across the market. On a second, the combined figure governs.
How fast do you need it? A second is a smaller transaction. Our files close in 5 to 7 days, and as quickly as 3 days on low documentation, and the fewer moving parts there are, the more reliably that holds.
A third option people forget
If the equity you want to use sits across several properties rather than in one, neither structure above is the efficient answer.
A blanket loan places one facility across multiple properties, and cross-collateralization pledges additional property to support a loan that one asset alone would not carry. Investors with several holdings often find that a single structured facility beats three separate transactions on cost and on administration. Our post on blanket loans explained covers how they work.
The purpose question applies to both
Whichever structure you choose, the classification of the loan depends on what the money does.
A business purpose loan funds business or investment. A consumer purpose loan funds personal, family or household needs, and carries verified income requirements, disclosures and waiting periods, plus a right of rescission on certain transactions secured by a primary residence.
The property does not decide it. A cash-out refinance of a rental spent on a personal obligation is consumer purpose. A second on your own home funding an investment purchase can be business purpose with the use documented. The classification changes the lender, the documents and the timeline, so state the purpose plainly at the first call. Our post on business purpose vs consumer purpose loans covers the test.
Do the comparison properly
Build both scenarios on one page.
For the refinance: the new loan amount, its rate and payment, the closing costs on the full amount, any prepayment charge on the loan being replaced, and the total monthly cost of all debt on the property afterward.
For the second: the existing first’s payment unchanged, the new second’s payment, the closing costs on the smaller amount, and the same total monthly cost figure.
Then add the horizon. Multiply the monthly difference by the months you actually expect to hold, and add the transaction costs of each. The winner is usually obvious once the comparison is stated that way, and it is frequently not the one with the lower headline rate.
Where to start
The business purpose second mortgages guide covers the second lien route in depth, the second and third mortgage program page sets out the structure, and the pricing guide covers how private loans are priced.
Send us the property, the existing first’s balance and terms and what the money is for, at (619) 617-2797 or through the borrow page. We will build the comparison with you rather than sell you one side of it.
