Second Mortgage vs. Home Equity Loan: Is There a Difference?
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Richard Haddad Executive EditorRichard Haddad is the executive editor of HomeLight.com. He works with an experienced content team that oversees the company’s blog featuring in-depth articles about the home buying and selling process, homeownership news, home care and design tips, and related real estate trends. Previously, he served as an editor and content producer for World Company, Gannett, and Western News & Info, where he also served as news director and director of internet operations.
As a homeowner, it’s likely you’ve been paying your mortgage payments for some time and feeling good about the equity you’re building. Now, something’s come up. You may need money to renovate, make repairs, cover a large expense, or make a major purchase, such as an RV, or even to buy another home.
You’re pondering: second mortgage vs. home equity loan. But what do these terms really mean for you? In this guide, we’ll clarify these homeowner borrowing tools and help you determine which option might be best for your situation.
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Second mortgage vs. home equity loan
There’s often confusion about the terms “second mortgage” and “home equity loan.” In reality, a home equity loan is a type of second mortgage. Similarly, a home equity line of credit (HELOC) is also considered a second mortgage.
Both home equity loans and HELOCs use your home as collateral, but they offer different features and benefits. In the following sections, we’ll clarify these concepts and explain when and how they might be a solution to access the cash you need.
What is a second mortgage?
A second mortgage is an additional loan taken out against your home’s equity on top of your primary mortgage. A second mortgage is sometimes called a “junior lien” because it’s a loan that’s subordinate to your first (or senior) mortgage. In case of default, the second loan is paid off after the first.
The two main types of second mortgages are:
- Home equity loans: A lump-sum loan with fixed interest rates and monthly payments.
- Home equity lines of credit (HELOCs): A revolving line of credit with variable interest rates and flexible payment terms.
What is a home equity loan?
A home equity loan allows you to borrow a fixed amount of money against your home’s equity. You receive the funds in a lump sum and repay it over a set period with fixed monthly payments. This option is ideal for large, one-time expenses like home improvements or debt consolidation.
Home equity loan example
Here’s an example of how a home equity loan works. Say your home is worth $500,000, and you still owe $250,000. In a typical scenario, the most you’d be able to borrow against the equity using the 80% rule is $150,000.
Here’s how that breaks down:
$500,000 x .80 = $400,000
$400,000 – $250,000 = $150,000
Below is a table illustrating what your monthly payments might be on a $150,000 home equity loan using current interest rates for equity-backed loans, which are typically higher than 30-year fixed mortgage rates.
| Loan term | Loan amount | Interest rate | Monthly payment |
| 30-year | $150,000 | 9.40% | $1,250.35 |
| 20-year | $150,000 | 9.35% | $1,383.54 |
| 15-year | $150,000 | 9.35% | $1,552.79 |
| 10-year | $150,000 | 9.35% | $1,928.67 |
| 5-year | $150,000 | 9.35% | $3,139.29 |
Source: U.S. Bank home equity loan calculator (As of July 2024 with a 680-729 “good” credit score)
What is a home equity line of credit (HELOC)?
A HELOC, or home equity line of credit, functions more like a credit card. You’re given a credit limit based on your home’s equity and can draw from it as needed. Payments and interest are only due on the amount you actually use, making it a flexible option for ongoing expenses or emergencies.
HELOCs typically have a variable interest rate, meaning their interest rates fluctuate based on the prime rate.
HELOC example
Imagine a homeowner who wants to fund various home projects over several years. They choose a HELOC with a $50,000 limit, withdrawing funds as needed and paying interest only on the amount borrowed, with the flexibility to repay and borrow again during the draw period.
If the homeowner withdrew the entire $50,000 at a 10.270% variable annual percentage rate, the monthly payment might be around $449 on a 30-year term.
If, instead, the homeowner was approved for $150,000, as in our home equity loan example above, and withdrew the entire amount at a lower 9.32% variable annual percentage rate, the monthly payment might be around $1,242 on a 30-year term.
*Estimates created using Bank of America’s HELOC calculator
Should I get an equity-backed loan?
Deciding to leverage your home’s equity through a second mortgage, such as a home equity loan or a HELOC, can be a smart financial move. However, it’s important to weigh the benefits and risks to determine if this type of loan aligns with your financial goals and situation.
An equity-backed loan can offer access to substantial funds at relatively low interest rates compared to other types of credit. But it also means putting your home on the line.
Let’s look at some key pros and cons to help you make an informed decision.
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Pros and cons of having a second mortgage
Pros
- Flexible payments: HELOCs offer flexibility in how and when you repay the borrowed amount.
- Funds available for emergencies: You can access substantial funds quickly, which can be crucial in urgent situations.
- Less costly than other loans: Second mortgages often have lower interest rates compared to personal loans and credit cards.
- Can obtain funds quickly: The approval process can be faster, especially if you have significant equity in your home.
Cons
- Interest rates might go up: HELOCs typically have variable interest rates, which can increase over time.
- Additional monthly payments: Managing another loan means additional monthly financial obligations.
- You may spend more than planned: Easy access to funds can lead to overspending and increased debt.
- Higher risk of losing your home: Defaulting on payments can result in foreclosure, as your home is the collateral.
When is a home equity loan a good choice?
A home equity loan might be the right option for you if you:
- Consolidate debt for a single payment: Streamline your debts into one manageable monthly payment at a potentially lower interest rate.
- Make major home improvements: Fund substantial renovations that can increase your home’s value.
- Pay for college or other education: Cover large educational expenses with predictable repayment terms.
- When you know the amount you need: If you have a clear idea of the required amount, a lump sum with fixed payments is ideal.
When is a HELOC a good choice?
A HELOC could be the best fit if you need to:
- Consolidate higher-interest debt: Pay off high-interest debt with a potentially lower-rate line of credit.
- Cover ongoing revolving expenses: Flexible borrowing can help you manage ongoing costs, such as medical bills or home improvements.
- Avoid a cash-out refinance: Access your home’s equity without refinancing your primary mortgage.
- Buying an additional home: Use the line of credit for a down payment on your next house or to purchase an investment property.
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FAQs on second mortgages
How much do second mortgages cost?
Homeowners can expect to pay between 2%-5% of the loan amount in closing costs for a second mortgage. This includes fees for appraisal, origination, title search, and other associated expenses.
How soon can I get funds from a second mortgage?
The timeline to receive funds from a second mortgage varies, but typically, it can take anywhere from 2 to 6 weeks from the application to the disbursement of funds. This depends on the lender’s process and the completion of the required documentation.
Will I need to purchase a home appraisal?
Yes, most lenders will require a home appraisal to determine the current value of your home. This appraisal is vital in assessing how much equity you have and how much you can borrow.
How can I estimate a second mortgage payment?
Homeowners can use online calculators to estimate their second mortgage payments. A home equity loan calculator can provide an estimate based on the loan amount, interest rate, and repayment term. Similarly, a HELOC calculator can help estimate payments based on the credit limit, variable interest rate, and repayment schedule.
Summary: A home equity loan is a second mortgage
In summary, understanding that a home equity loan is a type of second mortgage is helpful for making informed borrowing decisions. Both home equity loans and HELOCs allow you to leverage your home’s equity, but they serve different purposes and have distinct advantages and disadvantages.
By carefully considering your financial needs and goals, you can choose the option that best suits your situation, whether it’s a fixed home equity loan for a lump-sum expense or a flexible HELOC for ongoing costs. Always consult with a financial advisor to determine the most suitable option for your unique circumstances.
Header Image Source: (Pascal Bernardon/ Unsplash)
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