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.
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.
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 second 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.
- 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 a Second Mortgage Is 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 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 Second Mortgages Higher Than First Mortgages?
Generally, second mortgage interest 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 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.
Why Second Mortgage Loans and HELOCs Will Roar Back Comeback in 2024
Mortgage rates are on the rise as of May of 2023, most recently flirting with 5% for a 30-year mortgage. In fact, the fixed rate product hit 5.02% before dropping into the 4s again. This was the highest mortgage rates have been since 2003, and before that, rates hadn’t hit 5% since 2011. The higher rates have led to mortgage volume dropping 41% from a year ago as fewer people are buying homes and doing refinances.
Also, remember that interest rates have been in the 3% range for several years, so millions of homeowners already have bargain-basement mortgages. Higher mortgage rates can be a headache for home buyers as they can’t afford as much home as a year or two ago. Higher rates for mortgages also can be problematic for homeowners who planned to do a cash-out refinance.
Cash-out refinance mortgages are popular with homeowners who want to get a lower mortgage rate and pull-out cash for home improvements and other purposes.
The good news for homeowners who are flush with equity after seeing rising home values for several years: You still can get a second mortgage loan or home equity line of credit (HELOC) to get the cash you need and keep your first mortgage in place.
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.
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.
A HELOC is a revolving credit line that operates like a credit card. Most lenders offer several ways you can access that money, including online transfer, writing checks, or using a debit card connected to your credit line account. HELOCs have advantages over other second mortgages such as a home equity line because the closing costs are lower. A HELOC also offers a low introductory rate, so you can pay interest only during the draw period. However, the interest rate can rise after the introductory period ends, and you eventually need to pay both interest and principal back.
This second mortgage also is advantageous because you can access the cash at any time, but there is no interest on money you haven’t used. Some homeowners like to use a second mortgage as an emergency fund. Just make sure your lender doesn’t require a minimum withdrawal every year.
HELOCs have been quite popular during the pandemic as many people lost jobs and hours and were strapped financially.
2 Phases with Home Equity Lines of Credit
Most HELOCs have two parts or phases. The first is usually called the draw period and it is 10 years in length when you can tap the money as you wish. Most HELOCs only require you to make interest-only payments during this time, but you may be able to pay extra if you like. After the draw period concludes, you may ask your lender for an extension, but normally the loan goes into the repayment period. From this time, you cannot access your credit line anymore, and must make interest and principal payments until you have zero balance.
Most mortgage lenders use a 20-year repayment period and a 10-year draw phase. As you repay, you need to repay the money borrowed and whatever the interest rate is. Some mortgage lenders offer various repayment options during the 20-year repayment phase. Keep in mind that while you pay interest only during the draw period, payments during the repayment phase could double.
Say you get an $80,000 second mortgage with a 7% rate. This would cost about $470 monthly during the draw period and rise to more than $700 per month when you have to repay principal.
The increase in payments when the repayment period starts can leave people surprised. But you will know well in advance when the repayment period begins and what the payment will be.
Plus, many homeowners make more money after 10 years, so it isn’t a problem to make the higher payment.
Why Do People Get HELOCs?
One of the greatest things about a HELOC is you get low-interest money that can be used for any purpose. From a financial perspective, one of the best ways to use the money is to renovate your home.
If you put your equity into remodeling your kitchen and expanding the family room, there could be a substantial increase in value to the property. And of course, there will be greater enjoyment in your home for the entire family.
Other 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.
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.
But the money must be used to ‘substantially improve’ the property. This means that you need to make actual home improvements, and not simple repairs.
For example, you can write off the interest on a $30,000 HELOC if the money is used to remodel the kitchen. But if the funds just pay for making various repairs around the home that don’t add to its value, you can’t write off the interest. Read about HELOC interest and tax deductibility.
2nd Mortgage Takeaways
Do you have growing equity in your home? If so, you may want to pull out some of that cash to remodel your kitchen, pay off debt, or fund your child’s college tuition.
You can tap your equity with a mortgage refinance or a second mortgage. If you already have a low-interest rate on your first mortgage, consider getting a second mortgage.
With mortgage rates nearing 5%, millions of homeowners have first mortgages that they don’t want to refinance. So, what should they do to get the cash they want? A home equity line of credit can be the perfect financial tool for your needs. You keep your first mortgage in place at a low rate and get the cash you want for home improvements at a low rate, too!
Talk to your second mortgage lender about a HELOC soon; it’s been reported that the Federal Reserve will raise rates several times in 2023. They already have increased rates twice. Some say the Fed will raise rates to about 2.5% by the end of the year.
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.
- Second Mortgages vs. Home Equity Loans
- How Does a Home Equity Line of Credit Differ from a Second Mortgage?