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There’s some confusion surrounding the terms “second mortgage” and “home equity loan.” So, let’s be clear: A home equity loan is a type of second mortgage. But that’s not all you should know.
Here’s what else you need to know about second mortgages and home equity loans:
What is a second mortgage?
A second mortgage is another home loan taken out against an already-mortgaged property. They are usually smaller than a first mortgage.
The two most common types of second mortgages are home equity loans and home equity lines of credit (HELOC).
Like a first mortgage, your home is used as collateral for a second mortgage. Should a foreclosure happen, the first mortgage lender is first in line to get repaid. The second mortgage lender is repaid next.
What is a home equity loan?
A home equity loan is a type of second mortgage that lets you borrow against your home’s value. You’ll get the proceeds from a home equity loan in a lump sum — similar to a personal loan — and the loan’s interest rate will be fixed.
By contrast, a HELOC allows you to borrow smaller sums as needed, and the interest rate is usually variable. Traditionally, you’ll need to retain 20% equity in your home to qualify for a home equity loan.
Here’s an example of how someone could access their equity through a home equity loan:
- Home value: $250,000
- Mortgage balance: $150,000 or 60% of the home’s value
- Equity to retain: 20% or $50,000
- Equity available to borrow: 20% or $50,000
While a home equity loan would give you $50,000 up front in the above example, a HELOC would give you access to a $50,000 line of credit. You might never borrow the full $50,000, and you’ll only pay interest on the amounts you actually borrow.
Here are the most important differences between a home equity loan and HELOC:
|Home equity loan||Home equity line of credit (HELOC)|
|Disbursement||Cash up front in one lump sum||Draw cash as needed, up to limit|
|Repayment||Fixed monthly payments||Open-ended. Interest-only payments often allowed during draw period|
|Interest rate||Typically fixed||Usually variable|
|Interest charges||Interest charges apply to entire loan balance||Only pay interest on amount you draw|
An alternative to second mortgages
One alternative to a second mortgage is a cash-out refinance. With a cash-out refi, you pay off your existing mortgage with a new, larger mortgage and pocket the difference.
The biggest benefit to choosing a cash-out refinance over a second mortgage is that cash-out refinance rates tend to be lower. This is because a cash-out refi is a first mortgage. The biggest drawback is that since you’ll be getting a larger loan, your closing costs, particularly the origination fee, may be higher.
Credible doesn’t offer home equity loans or HELOCs, but we can help you compare the latest mortgage refinance rates, including those for a cash-out refinance. In just a few minutes, you can get actual personalized rates from our partner lenders — it’s free, and you don’t even have to leave our platform.