Second Mortgage vs. Home Equity Loan: Answering Homeowner FAQs
Home equity is one of the biggest financial tools homeowners can use to access cash, which you can tap into through a second mortgage.
This guide will break down the two different types of second mortgages and and explain how they work.
A second mortgage is a loan that a homeowner can take out in addition to their first mortgage, using their home as collateral. That means that if you do not pay back the loan during the appropriate repayment period, your lender has the right to foreclose your house.
Second mortgages can be valuable financial tools for situations such as major home improvements or debt consolidation.
There are two different types of “second mortgages.” The name encompasses both fixed-payment home equity loans and HELOCs (Home Equity Line of Credit).
A home equity loan provides a lump sum you must repay over a fixed term with a set interest rate. Since payments remain the same each month, this option works well for homeowners who need predictable payments and a large sum up front — such as for renovations, debt consolidation, or major expenses.
What Is A HELOC?
HELOCs (Home Equity Line of Credit) are credit lines that you can use and reuse. They start with interest-only payments and then switch to principal-plus-interest repayment. You’ll start with a lower monthly payment, and then your monthly mortgage payment will increase.
A home equity loan is a specific type of second mortgage. A home equity loan provides a lump sum up front and is repaid in fixed monthly installments over a set term. This will sound very similar to other mortgages.
In contrast, another type of second mortgage is a HELOC that operates as a revolving line of credit. You borrow as needed during a “draw period” (typically 5 to 10 years), paying interest only on the amount you use.
Home equity loans usually come with fixed interest rates, meaning your monthly payments remain the same throughout the loan term. HELOCs often have variable interest rates that can change based on market conditions.
A home equity loan is a type of loan ideal for homeowners with a clear, one-time financial goal. Because it comes with a fixed interest rate, your payments stay the same for the life of the loan. This makes it a predictable option.
Home equity loans often offer lower interest rates than unsecured debt like credit cards or personal loans, thanks to your home serving as collateral. If rates rise in the broader market, your payment remains unchanged, shielding your budget from volatility.
Also, home equity loans are tax-friendly. According to IRS guidelines, the borrowed interest can be exempted from taxation if the borrowed funds are used to “substantially improve” your real estate.
Ultimately, this loan proves beneficial for consolidating debt. By rolling high-interest debt, such as credit card bills or personal loans, into a home equity loan, you pay less in total interest. Over time, consistent repayments can even boost your credit score, which shows reliability to future lenders.
With the HELOC second mortgage option, you can withdraw money multiple times up to your approved limit — this is great for ongoing expenses.
Additionally, HELOCs typically begin with variable rates, which can initially be lower than those of fixed-rate loans. Some lenders offer options to lock in rates on portions of your balance.
Another benefit is that many HELOCs allow you to make interest-only payments during the draw period, keeping initial costs low and freeing up cash flow for other expenses.
In summary, here are some key differences in the benefits of the two types of second mortgages: HELOCs and Home Equity loans.
They may also have the potential for tax deductions when used for large home improvements.
HELOCs also have the potential for lower initial rates.
While home equity loans and HELOCs unlock your home’s financial potential, they also come with financial risks that you need to consider carefully.
For instance, no matter which loan type you choose, you’re borrowing against your home’s value. This means that defaulting on payments puts you at risk of losing your home to foreclosure.
Additionally, the stability that comes with home equity loans also comes with a serious trade-off: interest costs. You’ll receive a lump sum and start paying interest on the entire amount borrowed right away. Also, lenders often require at least 15 to 20% equity in your home and a strong credit score (680+) to qualify.
HELOCs might tempt you to overspend. The revolving credit line can feel like “free money,” encouraging borrowers to dip into funds for non-essentials. Once the draw period ends, you must start repaying both principal and interest — a shift that can cause a sudden spike in monthly payments, which often catches borrowers off guard.
All in all, both options aren’t as liquid as other forms of credit. A home equity loan is the most restrictive. If you need additional funds, you must apply for another loan.
A HELOC, while more flexible, can still pose the same liquidity challenges. If housing market conditions change or your financial profile weakens, your lender may freeze or reduce your credit line.
Consider the following factors when choosing between a HELOC second mortgage vs. a home equity loan second mortgage:
Choose the home equity loan when:
Use the HELOC when:
Ultimately, the choice of a second mortgage depends on your financial needs and your capacity to take on risk. For stability, home equity loans are a viable option, providing the assurance of fixed payments. If you have variable demands, HELOCs can be a more suitable option, offering liquidity for fluctuating expenses.
Your choice of a second mortgage depends on striking a balance between predictability and flexibility.
Whatever path you choose, ProFed Credit Union supports your journey to financial freedom. From checking accounts and credit cards to savings plans, we provide the tools and expertise to secure your future. Contact us today or schedule an appointment to find the right financial solution for you.