Home Equity Loans vs Second Mortgages: Which is Better for You?

If you’re a homeowner looking to tap into your home’s equity, you may be wondering whether a home equity loan or a second mortgage is the better option. Both allow you to access the equity you’ve built up in your home but they work differently. I’ll explain the key differences between home equity loans and second mortgages, so you can decide which fits your needs.

What is a Home Equity Loan?

A home equity loan is a type of loan that allows you to borrow against the equity in your home Equity is the difference between your home’s market value and how much you owe on your mortgage.

For example, if your home is worth $300,000 and you owe $180,000 on your mortgage, you have $120,000 in equity ($300,000 – $180,000 = $120,000)

With a home equity loan, you can tap into that equity and get a lump sum of cash. The amount you can borrow depends on how much equity you have as well as your lender’s policies. Most allow you to borrow up to 85% of your equity.

Home equity loans have fixed interest rates and set repayment terms, usually between 10-20 years. You’ll receive the loan in one lump sum payment, then make fixed monthly payments until it’s paid off. The home serves as collateral, meaning it could be foreclosed on if you default.

What is a Second Mortgage?

A second mortgage also allows you to leverage your home’s equity, but works differently than a home equity loan. It is an additional mortgage taken out on a home that already has a first mortgage.

The first mortgage likely financed your initial home purchase. A second mortgage gives you access to your accrued home equity without refinancing or altering your existing mortgage.

Like all mortgages, second mortgages use your home as collateral. They also have interest rates and monthly payments, though rates may be higher than first mortgages. This compensates for the increased risk lenders take on with a second lien on the home.

Home Equity Loan vs Second Mortgage: Key Differences

Though both tap home equity, there are some important ways home equity loans and second mortgages differ:

• Payment structure: Home equity loans provide you with a lump sum upfront, which you repay through fixed monthly payments over a set term. Second mortgages work like traditional mortgages with regular monthly payments.

• Interest rates: Home equity loans tend to have higher but fixed interest rates. Second mortgages usually have adjustable rates that fluctuate with market conditions.

• Risk: Because second mortgages are repaid over time like a traditional mortgage, some see them as a lower risk option. Home equity loans provide a lump sum upfront, requiring budgeting.

• Uses: The lump sum structure of home equity loans makes them suited for large, one-time expenses. Second mortgages can work for a variety of ongoing borrowing needs.

• Qualification: Home equity loans may have more flexible qualification requirements than second mortgages or cash-out refinancing.

• Closing costs: You’ll incur closing costs with both, but second mortgages may have higher upfront costs. Shop around for the best deals.

• Foreclosure order: If you default, first mortgages get paid before second mortgages. Home equity loans are generally second liens subordinate to first mortgages.

When to Consider a Home Equity Loan

Based on their structure, home equity loans are a good fit for certain situations:

• Large, one-time expenses – The single payout makes home equity loans useful for financing large, one-time costs like home renovations, repairs, medical bills, or college tuition.

• Consolidating high-interest debt – The lower interest rates mean home equity loans allow you to consolidate and pay off credit cards and other debts more affordably.

• Quick access to funds – Home equity loans may provide faster access to funds than alternatives like cash-out refinancing. This can be crucial in emergencies.

• If you qualify – Some may find it easier to qualify for a home equity loan than a second mortgage or cash-out refinance if they have excellent credit and equity.

• Shorter-term financing – 10 or 15 year home equity loan terms allow you to pay the debt off faster than a traditional 30-year second mortgage.

When to Consider a Second Mortgage

Here are some instances when a second mortgage could be preferable:

• Lower, adjustable interest rates – Second mortgages often start with lower rates than home equity loans. The adjustable rates can go up over time, but they may initially be more affordable.

• Ongoing borrowing needs – Since second mortgages function like regular mortgages with monthly payments, they can work for ongoing borrowing over an extended period.

• Home improvements – Second mortgages allow you to finance renovations or repairs over time rather than in a single lump sum.

• If you don’t qualify for a home equity loan – Second mortgages may be an option if you don’t qualify for a home equity loan due to credit scores or other eligibility factors.

• Investment property financing – Second mortgages can provide financing for investment or rental properties when you may not qualify for other types of loans.

• Lower upfront costs – The closing costs and fees for a second mortgage may be more affordable than a home equity loan, depending on loan amount and lender.

Pros of Home Equity Loans and Second Mortgages

Despite their differences, home equity loans and second mortgages share some general advantages:

• Access home equity – They allow you to leverage your home equity for access to funds when needed.

• Potentially lower interest rates – Compared to options like personal loans or credit cards, both tend to offer lower interest rates, saving on borrowing costs.

• Consolidate debts – You can consolidate higher interest debts into one lower monthly payment.

• Tax benefits – The interest may be tax deductible if used for home improvements that increase property value. Consult a tax advisor.

Cons of Home Equity Loans and Second Mortgages

There are also some potential downsides with both:

• Closing costs – You’ll incur upfront costs like appraisal fees, origination fees, and more with any home equity loan or second mortgage.

• Risk of foreclosure – As with all mortgages, failure to repay could result in foreclosure and the loss of your home.

• May spend more than anticipated – Large lump sum home equity loans could lead some borrowers to overspend.

• Variable/rising rates – Second mortgage rates may climb over time, increasing costs. Home equity loans typically have fixed rates.

• Decreased home equity – Borrowing against your home equity reduces the equity available for future needs or emergencies.

Tips for Getting a Home Equity Loan or Second Mortgage

If you think a home equity loan or second mortgage may be right for you, here are some tips:

• Shop around and compare options from multiple lenders – rates and terms can vary.

• Look for low origination fees to reduce upfront costs.

• Opt for the shortest term possible to pay off the debt faster.

• Prioritize low, fixed interest rates whenever possible.

• Only borrow what you can comfortably afford to repay to avoid default.

• Have a plan for spending the proceeds responsibly if taking a lump sum home equity loan.

• Consult a financial advisor to determine if borrowing against home equity is your best option.

Which is Better – Home Equity Loan or Second Mortgage?

There’s no one-size-fits-all answer – it depends on your specific needs and financial situation. Home equity loans offer a lump sum for large expenses, while second mortgages provide ongoing access to home equity.

Carefully assess your borrowing needs, income, credit score, and priorities. Understand all the costs, terms, and risks before deciding if a home equity loan or second mortgage is the better fit for you.