When it comes to financing a home improvement project or covering some other big expense, homeowners have a few options. They can take out a second mortgage, which is a loan against the equity in their home; or they can take out a home equity loan, which is a loan against the value of the home minus what they still owe on the first mortgage.
Both of these loans come with risks and benefits, so it can be tricky to decide which one is best for you. Here’s a closer look at the differences between a second mortgage vs home equity loan to help you decide which is the right choice for you.
What is a Second Mortgage?
A second mortgage is a type of loan that is secured by the equity in your home. Unlike a first mortgage, a second mortgage is a junior loan, which means that it is subordinate to the first mortgage and is typically much smaller than the first mortgage.
Second mortgages have shorter terms, which makes them a less risky investment for lenders. As a result, second mortgages normally have a fixed or variable rate. This type of mortgage is given to the borrower as a lump sum and will need to be paid every month for a set period of time — usually 15 to 30 years.
Borrowers would typically use second mortgages for one of two purposes: to consolidate debt or to finance a large purchase. Debt consolidation loans are used to pay off multiple high-interest debts, such as credit cards so that you can focus on repaying one loan with a lower interest rate.
How does a second mortgage work?
A conventional mortgage is granted by financial institutions, including banks or credit unions, to a borrower to purchase a residence. Typically, the approved loan amount is up to 80% of the property’s appraised value. For instance, a property valued at $200,000 would be eligible for a mortgage amount of up to $160,000. The remaining 20%, which is equivalent to $40,000, would be paid by the borrower as a down payment.
A mortgage has two types of interest rates, which can either be fixed or variable rates. The amount to be repaid by the borrower includes the principal amount of the loan plus the interest over a fixed term, which is typically 15 or 30 years.
Longer-term mortgages are also available. For example, a mortgage with a duration of 40 years. And this post will help you decide if it’s the right fit for you: 40-Year Mortgage: Pros & Cons.
If a borrower default on payments, the collateral property will be foreclosed and seized by the lender. It will be sold by the lender at an auction to recover the money lent to the borrower. If this happens, the lender of the original or first mortgage will be prioritized and paid off in full first using the proceeds from a foreclosure sale, and the lender of the home equity loan called the second mortgage will only receive whatever is left.
What is a Home Equity Loan?
A home equity loan is a type of loan that allows the borrower to use the equity in their home as loan collateral. The value of the property will determine the approved loan amount, and the borrower typically makes equal monthly payments over a fixed period of time. These types of loans typically have lower interest rates than other types of loans, making them a popular choice for home improvements, debt consolidation, and other large expenses. However, because they are secured by your home, failing to repay a home equity loan can result in foreclosure. Before taking out a home equity loan, it is important to carefully consider your financial situation and make sure you will be able to afford the monthly payments.
How does a home equity loan work?
Equity is the difference between the appraised value of the property and the amount still owed on the mortgage. For example, if your original mortgage amount is $250,000 on a property valued at $400,000, your equity amount would be $150,000. If you are qualified, you can take out up to $100,000 as a home equity loan.
These types of loans are usually given as lump-sum payments, and the borrower is then responsible for repaying the loan over a fixed period of time, usually 5-15 years.
Is a Second Mortgage a Home Equity Loan?
Yes, a home equity loan is the same as a second mortgage because it allows borrowers to loan money using their property equity as collateral. A borrower will receive that loaned amount as a credit line, which is considered another loan payment to settle on top of the original primary mortgage. Hence, a home equity loan is similar to a second mortgage.
What are the benefits of a second mortgage and a home equity loan?
A second mortgage and a home equity loan can be attractive options for borrowers who need access to extra funds and can be a useful financial tool in a number of different situations. Here are some of the main benefits of both:
- Additional Fund. It can be used to finance just about anything. Whether you need to consolidate debt, make some repairs around the house, or buy a new car, a home equity loan can provide the funds you need.
- Home Renovations. If you are planning to make major renovations to your home, a second mortgage can provide the funds you need without putting your home equity at risk.
- Debt Consolidation. A second mortgage can be used to consolidate other debts, such as high-interest credit card debt. By taking out a second mortgage and using the proceeds to pay off other debts, you can reduce your overall monthly payments and save money on interest charges.
- Emergency Funds. A second mortgage can also be used as a source of emergency funds in case of unexpected expenses. By carefully considering your options and choosing the right lender, you can use a second mortgage to secure the financial stability of your family.
- Tax Savings. Are home equity loans tax-deductible? To answer this one commonly-asked questions: A home equity loan offers a lower interest rate than other types of loans and the interest on a home equity loan is often tax-deductible, which can save you money at tax time.
- Longer Repayment. Borrowers typically have up to 30 years to repay a home equity loan. This makes it easier to budget for the monthly payments and ultimately pay off the loan in full.
What are the risks of a second mortgage and home equity loan?
Taking out a second mortgage is a big financial decision that should not be made lightly. There are a number of risks associated with a second mortgage, including the following:
1. You could lose your home if you default on the loan.
2. The interest rate on a second mortgage is often higher than the rate on a first mortgage, which means you will end up paying more in interest over the life of the loan.
3. Taking out a second mortgage will increase the amount of debt you owe, which could make it difficult to qualify for future loans or credit lines.
4. If you decide to sell your home before the second mortgage is paid off, you’ll need to pay off the entire loan to sell the property.
Taking the above-outlined risks into consideration, be sure to speak with a financial advisor to make sure it’s the right choice for you before making this decision.
2nd Mortgage vs HELOC
When it comes to taking out a loan against the equity in your home, there are two main options: a second mortgage and a home equity line of credit (HELOC). Both types of loans can be used for a variety of purposes, but there are some key differences to take into account before choosing one.
A HELOC functions like a credit card: you can choose when and how much to borrow up to your credit line limit, and you only have to pay interest on the amount that you actually borrow. With a second mortgage, you borrow a lump sum of money all at once and make fixed monthly payments over a set period of time.
The amount you owe on a HELOC fluctuates based on how much you have borrowed, and you only pay interest on the amount you have borrowed. The interest rate on a second mortgage is usually higher than the rate on a HELOC. While a second mortgage has a fixed interest rate.
Another difference between these two types of loans is the way they are paid back. A second mortgage must be paid back in full over the life of the loan, typically 15 or 30 years. A HELOC typically has a 10-year draw period during which you can borrow money as needed, followed by a repayment period.
You can also check our article about Mortgage: 30 vs 20 vs 10 Years and choose what suits you better.
If you’re a member of the navy federal credit union, you may be eligible for a home equity line of credit. This can be a great way to access the equity in your home to make improvements or consolidate debt. The navy federal home equity line of credit has a variable interest rate, so it’s important to understand how this can affect your monthly payments. There is also a minimum monthly payment required, which is based on the outstanding balance. Families who are struggling to make ends meet may find that the navy federal home equity line of credit is a helpful way to get the financial assistance they need.
Which one is right for you?
A second mortgage and a HELOC are both great options when it comes to taking out additional financing on your home. But which one is right for you?
What’s the purpose of a loan?
Generally speaking, a second mortgage is best for larger, one-time expenses (e.g., a home improvement project, major medical bills, etc.), while a HELOC is more suited for smaller, recurring expenses (e.g., monthly credit card payments, home repairs, etc.).
For starters, a second mortgage is a fixed-rate loan, meaning that your interest rate will stay the same for the life of the loan. A HELOC, on the other hand, is a variable-rate loan, which means that your interest rate can fluctuate over time. Second mortgages typically have lower interest rates than HELOCs.
HELOCs offer more flexibility when it comes to making payments. You only need to make payments on the amount that you actually borrow (plus interest).
With a second mortgage, you will typically make higher monthly payments as you do with your first mortgage.
Second mortgages’ terms are anywhere from 10 to 30 years while HELOC is a 30-year loan. The draw period would usually take up to 10 years, and the repayment period would take additional 20 years.
The Bottom Line
Deciding whether to take out a second mortgage or a HELOC can be a difficult choice. Both options have their pros and cons, and the right decision will depend on your personal financial situation. Ultimately, the best way to decide which option is right for you is to speak with a financial advisor and carefully consider your unique circumstances.
Kris Reid is the CEO of Ardor SEO, a company that helps real estate professionals get more leads and customers to predictably grow their business.
Over the years, Kris acquired extensive knowledge of SEO and its practical applications in various industries, with the main focus on real estate.
In 2021 Ardor launched the Icons of Real Estate Podcast to share proven strategies from the top producing icon agents with the real estate community.
After obtaining the real estate license in 2022, Kris joined eXp Realty and launched Homes by Ardor, the platform that was built to be the fastest way to buy or sell a house. Homes by Ardor also provides leads for its partner companies and realtors.