Deciding between a Home Equity Loan and a Second Mortgage

When homeowners need extra money, they consider taking out a home equity loan, second mortgage or another type of loan. Some reasons behind the need could be home renovations, college tuition, and credit card debt consolidation. Depending on the purpose and the amount of money needed, choosing amongst a home equity loan, second mortgage and another type of loan may be difficult. In order to make the right decision, it is important to understand how both types of loans work.

Home Equity Loans

Home equity loans, or home equity lines of credit (HELOC) work similarly to credit cards. The limit on your HELOC will be determined by your credit score and the appraised value of your home. Your lender will allow you to borrow up to 75 percent of the appraised value of your home, minus the amount of money you currently owe on your mortgage, provided you have good credit.

There are various payment options available, but the interest rates are always variable with a HELOC. With some lines you may be given an actual card to use for purchases.

In many cases, the HELOC is only allowed for a specified period of time, which can be 5 to 20 years. Upon the end of the period, you are required to repay the full remaining balance of the borrowed money plus interest in a lump sum, called a balloon payment. Sometimes the remaining balance is amortized and you are required to begin payments without further access to the line.

Second Mortgages

Second mortgages are similar to an initial mortgage in that there is a fixed amount given in a lump sum and the loan is repaid over 15 to 30 years. The interest rates could be higher on a second mortgage than an initial mortgage, however the interest rate is fixed. Unlike with refinancing, this type of loan does not replace the original mortgage, and those payments must also continue. The current interest rates available, your credit history and the value of your home will all play a role in the factoring of the amount you will be allowed to borrow.

Which One Is Right for You?

A second mortgage is usually a better choice if you wish to pay for a single large expense such as a college education, renovations, or a wedding. As long as the total amount remaining on your initial mortgage and the second mortgage to not exceed the value of your home, a second mortgage can save you money over time, especially if you repay the loan early.

A home equity line of credit might be a good idea if you wish to cover reoccurring expenses such as college room and board, textbooks, or other bills. If you are disciplined with credit, and can limit the use of the line to only covering needs, a HELOC might work for you.

Make your decision carefully, as you could lose your home if you are unable to repay either your second mortgage or a home equity loan. It may be that another type of loan entirely may work better for you.