Borrowing More Money

If you bought your home in the 1990s or early 2000s, it probably is worth more today than you paid for it. At the same time, you have been paying off your old mortgage.

The equity that you have in your home is the value of the home less the outstanding mortgage balance. See the example in Figure 8.10.

FIGURE 8.10 Building Up Equity

Building Up Equity

How to Borrow against Your Home Equity

You can borrow more money using your equity as collateral in one of two ways:

1. Replace your old mortgage with a larger new one.

2. Get a second mortgage, leaving your first mortgage in place.

There is no formula or rule of thumb to tell you which method is best. The choice must be based on what you plan to do with the extra money, how much you need, and how quickly you plan to pay it off. You are borrowing more money, not saving money. Your new7 monthly payments probably will be higher, and your interest rates also may be higher.

If you need a lot of money over a long period, you could refinance your first mortgage, replacing it with a larger one, or you could get a long-term, fixed-rate second mortgage. Either choice serves the same purpose. To choose one method over the other, compare the refinancing costs and interest rates of each. (See figure 8.11.)

FIGURE 8.11 Ways to Tap Equity

Ways to Tap Equity

Choosing an Equity Loan

Carrying through with the example of the home purchased in 1981, assume that you have a $61,400 mortgage balance on a home that now is worth $125,000. Suppose that you want to borrow $35,000 to add some new rooms to your home. Your choice is between a new 30-year fixed-rate mortgage at 8.5 percent plus three points and $1,000 in settlement costs or a 15-year fixed-rate second mortgage at 10 percent plus one point and $500 in settlement costs. (See Figure 8.12.)

Option 1: Get new first mortgage

• Loan amount: $100,400

• Monthly payment: $771.99

• Refinancing costs: $3,500

• Interest rate: 8.5%

Option 2: Get second mortgage; retain old first mortgage

• Loan amount: $35,850 (2nd) + $61,400 (1st) = $97,250

• Monthly payments: $385.25 + $51.3.64 = $898.89

• Refinancing costs: $850

• Interest rate (blended): ($35,850 × 10% + $61,400 × 7%) ÷ $97,250 = 8.1%

FIGURE 8.12 Choosing an Equity Loan: First Mortgage versus Second Mortgage

Choosing an Equity Loan: First Mortgage versus Second Mortgage

If you evaluate these two options, you can see that in this example, the second mortgage is a better choice than a new first mortgage. The monthly payments would be slightly higher ($898.99 versus $771.99), but the overall interest rate would be lower, the total loan amount would be lower, and the two mortgages would be paid off in 20 years versus 30 years for the new first mortgage.

If you need a large amount of money, but only for a few years, a second mortgage is cheaper than a new first mortgage because of the high cost of refinancing a first mortgage.

For the same reason, a second mortgage is usually better for borrowing a small amount for a long time. If you need a small amount of money for a short time, consider an unsecured personal loan. It may be less expensive than a second mortgage.

Home Equity Line-of-Credit Loans (HELOCs)

If you need additional funds, but not all at once (e.g., for college tuition payments over four years), inquire at your bank or savings-and-loan association about a line of credit secured by the equity in your home. A line of credit allows you to borrow what you need, as you need it, up to an agreed amount. You are charged interest on the outstanding balance.

HELOC rates are usually much lower than credit card rates, and many people use them to pay off all of their credit cards. Because HELOCs are mortgages, some or all of the interest may be tax deductible, unlike credit card interest.

Warning: It is not advisable to use a E1ELOC to pay off credit card debt and then run up more credit card debt. A HELOC is a lien on your home, and failing to make payments could lead to foreclosure.

Restrictions on Cash-Out Refinancing Transactions

When you refinance a first mortgage, increasing the loan amount to borrow more money, it is called a cash-out transaction. Maximum allowed LTV ratios are lower for cash-out refinancing transactions than mortgages for home purchase or refinancing transactions in which the loan is increased only enough to cover refinancing costs.

First Mortgages

Maximum LTV Ratio

Conventional mortgages

(Fannie Mae, Freddie Mac)


FHA mortgages


VA mortgages


Second Mortgages

Fannie Mae standards

70% combined LTV ratio

Most savings-and-loan associations

80% combined LTV ratio

Mortgage companies

up to 125% LTV (varies widely)

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