Second Mortgage vs. Home Equity Loan

July 28, 2011 No Comments »
Second Mortgage vs. Home Equity Loan

It’s time for another installment of “mortgage match-ups,” where I pit two common home loan programs against one another.

Today’s match-up: “Second mortgage vs. home equity loan.”

This is an epic battle of the junior liens, which while subordinate to their first mortgage brethren, can still hold their own in a fight.

But in this duel, we’re probably doing more to “clear things up” than we are comparing two differing loan programs.

Are second mortgages and home equity loans the same?

You see, when it comes down to it, most second mortgages are home equity loans. And vice versa.

So if you hear someone talking about one or the other, they could be talking about the same exact thing.

This is further complicated by the fact that most home equity loans are HELOCs, or home equity lines of credit. Confused yet?

You should be, considering the ambiguity of it all…let’s break it down once and for all.

Second Mortgages, HELOCs, Home Equity Loans

A second mortgage is any home loan that is subordinated behind (comes after) a first mortgage. So if you already have a mortgage and add on another one, it’s a second mortgage. Pretty simple, right?

This secondary loan could be a HELOC or a home equity loan.

A HELOC, as previously mentioned, is a line of credit. In other words, you get a home loan with a certain fixed line of credit, or draw amount, which you can use kind of like a credit card, except it’s secured by your home.

HELOCs are tied to the variable prime rate, and thus are adjustable-rate mortgages.

After the draw period ends, the amount drawn upon must be paid back during what’s called the repayment period.

*Note that while a HELOC is often used as a second mortgage, it can also be a stand-alone first mortgage, taken out by the homeowner when their home is free and clear, or it can be used to refinance an existing first lien.

Then we have the home equity loan, which can refer to both a HELOC or a closed-end second mortgage. Technically, it should be the latter.

A “closed-end second mortgage” is a home loan that operates similarly to a first mortgage in that it’s a fixed loan amount taken out all at once, not a line of credit.

This is a big distinction because it means you pay interest on the full amount borrowed immediately. And you get all the funds once the loan funds to use at your disposal.

However, a home equity loan can be a fixed-rate mortgage or an ARM. They are typically taken out as an alternative to a HELOC, especially as purchase-money second mortgages to extend financing if you don’t have a large down payment.

For example, a borrower can avoid paying mortgage insurance by taking out a first mortgage at 80 percent loan-to-value and a concurrent second mortgage for the remaining 20 percent, even though they receive zero down financing.

Unfortunately, many banks and mortgage lenders use the phrase “home equity loan” and “HELOC” interchangeably, adding to the confusion.

To ensure you actually get what you want/need, ask the loan officer or mortgage broker to explain the terms of each loan product clearly. And only proceed when you fully understand it.

Read more: How to get a mortgage.

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