Second mortgages and home equity loans are one in the same. Technically a home equity loan is a 2nd mortgage, because the equity loan or HELOC sits in second position on title to the house. Both home equity loans and 2nd mortgages are ways to borrow against the value of your home so its silly to listen to loan officers compare the two different loan products.

What Are the Differences between Second Mortgages and Home Equity Loans?

second mortgage and home equity loan

Both of these financing options employ your home as collateral, but there exist distinctions between the two types of 2nd mortgage programs, the HELOC and home equity loan.

A home equity loan features a fixed simple interest rate and is settled through consistent monthly payments, whereas a second mortgage may transition from a fixed to a variable interest rate.

Compare Home Equity Loans vs. HELOC

A home equity line of credit (HELOC) provides the flexibility to withdraw funds from a line of credit, while a second mortgage disburses a lump sum.

Both alternatives share common advantages and disadvantages, including the risk of foreclosure in case of non-repayment, the potential for negative equity, as well as supplementary loan fees and associated charges.

Learn more below about your options with a second mortgage, home equity loan credit, and other alternatives.

What Is a Second Mortgage?

A 2nd mortgage is another loan taken against your home that already has a mortgage. Homeowners often take out second mortgages to fund home improvements, such as home renovations, paying off debt, or funding college tuition. 2nd-mortgage lenders offer equity loans and credit lines.

There are two types of second mortgages that you can choose to access some of your home equity.

Home Equity Loan

  • A home equity loan is a fixed-rate, lump-sum loan with a term ranging from five to 30 years. The homeowner pays back the loan in fixed payments each month until the loan is paid off.
  • A home equity loan might be a good choice for you to fund a one-time major expense, such as buying a second home or paying down credit cards.
  • Borrowers may lower their monthly expenses with debt-consolidation from a home equity loan.
  • Home equity loans have fixed rates and the payments are locked in for the life of the loan, which makes your budgeting easier.
  • Your home secures the home equity loan, so you risk losing the property if you do not pay.

Home Equity Line of Credit (HELOC)

  • A home equity line of credit is another type of second mortgage. It has a variable interest rate and a credit line that you can draw from when you need it.
  • Home equity lines typically features a draw period of 10 years with interest-only payments during this time. After the draw period ends, you repay both principal and interest.
  • Minimum monthly payments are based on a variable interest rate. You can use the funds again as you pay off the credit line.
  • Homeowners may choose a HELOC if they anticipate making periodic payments for a home remodel or college tuition.
  • Some homeowners also like to have a line of credit available for financial emergencies. However, if your credit slips or you lose your job, your lender could reduce your credit line or even close it.

How Is a Home Equity Loan and Second Mortgage Calculated?

Lenders usually only allow you to take out a certain portion of your home equity. How much you can get depends on the home’s value and how much you owe on your first mortgage. Most 2nd-mortgage lenders allow you to take out up to 80% or 85% of your home’s value.

To determine how much money you can get, add how much you want to borrow to what you owe on your first mortgage. Divide that sum by your home’s current appraised value. That gives you your loan to value or LTV. For example, if your home is worth $300,000 and you owe $200,000 on your first mortgage, you have $100,000 of equity.

Most lenders will allow you to borrow up to $80,000 or $85,000 of your available equity. Taking out a second mortgage would give you a new loan balance of approximately $280,000.

Are Rates for Home Equity Loans and Second Mortgages Higher Than First Mortgages?

Generally, 2nd mortgage loan rates are higher. The mortgage lender is taking a bigger risk with a second mortgage loan. If you qualify for the second mortgage, the lender puts a new lien on the home. The second lien holder gets paid second in the event of a foreclosure. So, the rates for second mortgages reflect that higher risk. Still, rates for second mortgages are generally much lower than for personal loans or credit cards.

When Is a Second Mortgage a Good Idea?

Taking out a second mortgage may be right for you if you have a big expense but already have a low rate on your first mortgage. Most mortgage experts only recommend refinancing a first mortgage if you can save at least .5% on your rate. Getting a home equity loan or HELOC also can be a great move if you want money for something that has a solid return. Examples are a home improvement, a college education, or buying an investment property.

Second mortgages also can be used to pay off high-interest credit card debt, but beware of running up those credit cards again!

The mortgage interest on a second mortgage is tax-deductible IF you are using it to make a major improvement to your home. Examples are a kitchen or bath remodel, adding a swimming pool, or family room addition. Is it better to refinance or take out a home equity loan?

Should You Get a Home Equity Loan or a Line of Credit?

What is your risk tolerance? A home equity loan has a fixed interest rate and set payments for the life of the loan. People who like more financial certainty may prefer a home equity loan.

On the other hand, a home equity line of credit has a lower interest rate at first. But the rate can rise considerably in the future. If you can sleep at night with this uncertainty, a HELOC loan could work for you.

Also consider if you need a big sum of money right now, or funds periodically over time. A home equity loan gives you all your available equity immediately, and you pay interest on all of it from day one. A HELOC provides funds to you as you need them, and you only pay interest on what you use. Check today’s HELOC rates.

If you want to pull out the cash you need, it may be time to consider a HELOC with a low rate! This second mortgage is a great opportunity to obtain cash for home renovations and much more at a price much more affordable than personal loans and credit cards. More banks and lenders are beginning to approve the 2nd mortgage with bad credit.

Why Get a HELOC In Rising Interest Rate Markets?

A HELOC, which is a type of second mortgage, allows you to pull equity out of your home so you can use it for what you wish. While HELOCs have higher rates than first mortgages, they still are competitive and some of the least expensive money you can borrow. Getting a HELOC in a time of higher interest rates could help you get the cash you need when it doesn’t make sense to refinance your first mortgage.

HELOCs have been quite popular during the pandemic as many people lost jobs and hours and were strapped financially. If your home equity rates rise you can always refinance your HELOC into a new mortgage.

Why Do People Get HELOCs?

Many homeowners use their HELOC funds to pay off high-interest credit card or personal debt. This can be helpful with some credit cards charging 25% or more. Other options are to pay for a college education or pay for a vacation. But whether it’s worth using your equity and having a higher payment for those purposes is up to you.

HELOCs May Offer Tax Deductions Tapping your home equity for home renovations also carries other advantages. The IRS will let you write off some interest on home equity interest if you itemize on your tax return. With the new tax law enacted in 2017, married couples can deduct mortgage interest on up to $750,000 of mortgage debt if the debt is used for home improvements. The tax deduction works on first mortgages, HELOCs, and home equity loans. Read about HELOC interest and tax deductibility.

You never know what mortgage rates will do, but it seems likely that rates are on an upward trajectory. So, lock in your rate by talking to your lender about a HELOC today. Learn about the differences between cash out refinancing and home equity loans,

Takeaway on 2nd Mortgages and Home Equity Loans

Home equity mortgages and HELOCs are different types of second mortgages. Both pull equity from your home that you can use for cash purchases.

Home equity loans feature a fixed-rate, while HELOCs feature a variable interest rate.

Second mortgages may be the right choice for low-interest funds when your first mortgage rate is low and refinancing is out of the question. Talk to your mortgage lender to see if a home equity loan or HELOC is appropriate for your financial needs.

References

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