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The terms “home equity loan” and “second mortgage” often go hand in hand. In most cases, they’re interchangeable.
That’s right: A home equity loan is usually a second mortgage—though we’ll explain the rare exceptions.
In this guide:
- Is there a difference between a second mortgage and a home equity loan?
- When is a home equity loan not a second mortgage?
- Are the terms of a home equity loan or line of credit different?
- Is a home equity loan or line of credit better as a second mortgage?
- What type of second mortgage is right for you?
Is there a difference between a second mortgage and a home equity loan?
A mortgage loan is a lien against a property. This means the home is the collateral for the loan, and if the borrower fails to make payments, the lender can foreclose on that property, sell it off, and use the proceeds to recoup its losses.
A mortgage can be either a first-lien or a second-lien loan. Your primary mortgage—the one you use to purchase the house—is the first-lien loan, meaning the lender has the first right to your home should you default.
Any mortgage on top of that—including home equity loans and HELOCs—is a second-lien mortgage. The home equity lender is second in line if you fail to repay your loan. Your primary mortgage lender has claim to the property first. After that debt is settled, your home equity lender could use any remaining proceeds to pay off the balance.
When is a home equity loan not a second mortgage?
If you have 100% equity in your home, meaning you own it outright, a home equity loan is not a second mortgage.
For example, suppose you no longer have a mortgage or you paid for your home in all cash. A home equity loan would then be the first lien against the property. The home equity lender would have the right to foreclose on your home and use all the proceeds to satisfy the debt if you stop making payments.
Another situation in which a home equity loan or HELOC could be a first-lien loan is if you use the proceeds from your loan to pay off your mortgage balance.
Are the terms of a home equity loan or line of credit different as a second mortgage?
Second-lien loans are considered riskier for lenders. Because another lien takes precedence, lenders could be on the hook for significant losses should you stop making payments.
Due to this added risk, you can expect stricter eligibility requirements for most second-lien loans, such as higher credit score minimums. They typically have fewer repayment term options, too.
Lenders charge higher rates for these loans than traditional first-lien mortgages. They also want you to have a decent amount of equity in the home—10% to 20% after factoring in your second mortgage balance for most lenders. This ensures a buffer if your home loses value. (They could still sell it at a profit if its value falls 10% to 20%.)
You’ll be able to borrow a lower amount when a home equity loan or HELOC is a second mortgage. Again, lenders want you to retain equity to protect them if the market goes south.
Is a home equity loan or line of credit better as a second mortgage?
Both home equity loans and HELOCs can be smart options for a second mortgage. The right choice depends on factors including your financial need and budget.
Here’s a look at the high-level differences between a home equity loan and a home equity line of credit:
|Home equity loan||HELOC|
|Payment type||Lump sum payment upfront||Allows you to withdraw funds over time, usually 10 years|
|Interest rates||Usually fixed||Usually variable|
|Repayment terms||Fixed, principal and interest payments for 5 – 30 years||Interest-only payments during the draw period (usually 10 years)|
Principal plus interest payments during the repayment period (usually 20 years)
|Advantages||Consistent rate and payments for the entire loan term|
No ongoing fees
May offer a tax deduction
|Gives you access to cash for an extended period|
Low interest-only payments for the first 10 years
Only pay interest on what you borrow
May offer a tax deduction
|Drawbacks||Only one lump sum available|
Full payments start immediately
You could borrow more than you need, meaning more in long-term interest costs
|Interest rate and payments can fluctuate|
Often have transaction and maintenance fees
What type of second mortgage is right for you?
Consider how you’ll use the funds to choose the best type of second mortgage for your needs. If you have one considerable expense you want to cover, then a home equity loan could work with its lump sum payment. A HELOC may be better if you need access to funds for an extended period (ongoing college tuition payments, for example).
Your household budget and finances should also play a role. Do you need low payments for the next 10 years but know you can afford higher payments later? Then a HELOC could work. A home equity loan is likely the way to go if you need a consistent, reliable monthly payment from the start.
Once you decide which is best, check out our guides to the best home equity loans and best HELOC rates to start the process.
Author: Aly Yale