Second Mortgage Versus Home Equity Loan: Which Is Better?

Second Mortgage Versus Home Equity Loan: Which Is Better?

Second Mortgage Versus Home Equity Loan: Which Is Better?

Owning a home can yield valuable benefits, including the opportunity to accumulate shares in the property. Equity is the difference between what you owe on the home and its fair market value. There are several ways to draw on this capital, including taking out a second mortgage. But is there a difference between a second mortgage and a home loan? Making wise use of the equity you have accumulated in your home is best done by consulting an experienced financial advisor.

What is a second mortgage?

A second mortgage is any mortgage loan that is subordinated to a first mortgage. Typically, a first mortgage is a loan used to purchase a home. First mortgages are usually larger than second mortgages.

The house serves as collateral for a second mortgage. Like a first mortgage, the loan must be repaid over time with interest. So, if you have a first mortgage and a second mortgage, you will have two monthly mortgage payments.

If you default on one of your mortgage loans, the first mortgage lender has priority over the second mortgage lender for repayment. This means that if the home falls into foreclosure, the first lender would get paid before the second and it is possible that the second would receive little or nothing.

Second mortgages tend to have higher interest rates than first mortgages for this reason. A borrower who now has to pay two mortgage payments instead of one presents a greater risk to the lender. They then compensate by charging more interest to compensate for the possibility that the borrower will default.

What is a Home Equity Loan?

A home equity loan is a loan that allows you to borrow against the value of your home. In the simplest terms, it’s a second mortgage.

When you take out a home loan, you are taking the value of the equity out of the house. Typically, lenders will let you borrow 80% of the home’s value, minus what you owe on the mortgage. Some lenders can increase this to 85%.

Here is an example of how home equity loans work. Let’s say your house is worth $575,000 and you owe $350,000. The most you could borrow against equity using the 80% rule is $110,000.

Here’s what the math looks like:

$575,000 x 0.80 = $460,000

$460,000 – $350,000 = $110,000

The proceeds of a home loan are paid to you in a lump sum and you can use them as you wish. Common uses for home equity loans include:

The loan must be repaid with interest, and depending on the terms of the loan, the repayment can take anywhere from five to 30 years.

Second mortgage versus home equity loan

When you talk about second mortgages versus home equity loans, you’re actually talking about the same thing. A home equity loan is a second mortgage on a home that is secured by the underlying property. So there’s no “which is better?” question to be answered as they refer to the same thing.

Second Mortgage Versus Home Equity Loan: Which Is Better?

Second Mortgage Versus Home Equity Loan: Which Is Better?

The best question to ask yourself is “Should I get a home loan?” There are some pros and cons associated with having a second mortgage on your home.

As far as benefits go, the main benefit of a second mortgage is the ability to access the equity in your home. A home equity loan offers flexibility, as you can use the money for anything. So you could overhaul your kitchen, for example, if you want to make some updates that will improve the value of your home. Or you could use the money to consolidate and pay off high-interest credit card debt.

Home equity loan interest rates are often much lower than credit card interest rates or even personal loan rates for borrowers who have good credit scores. Opting for the shortest possible loan term can help you pay off a home loan faster, although keep in mind that this will result in a higher monthly payment.

The interest on a home loan may be tax deductible if you use the proceeds to purchase, build, or substantially improve the property that secures it. So again, if you’re renovating your kitchen to increase home value or replace your HVAC system, you may be writing off interest. The IRS has strict rules about this, so you may want to talk to your tax professional or financial advisor about what is and isn’t allowed.

The biggest disadvantage associated with having a home loan as a second mortgage is that it is secured by the home. This means that if you run into problems making your loan payments, you could be at greater risk of default and ultimately foreclosure. Not only would you lose your home, but you’d be without all the money you’ve invested in it over the years.

Home equity loan against HELOC

A home equity line of credit or HELOC is another type of second mortgage loan. Like a home loan, it is secured by the property but there are some differences in how they work.

A HELOC is a line of credit that you can draw on as needed for a specified period of time, typically up to 10 years. At the end of the withdrawal period, you will enter the repayment period, which can last up to 20 years. At this point, you will repay the amounts withdrawn from the credit line with interest.

HELOCs can have variable interest rates while home equity loans more often have fixed interest rates. The amount you can borrow can be higher than with a home equity loan. For example, lenders may use a 90% principal limit when determining HELOC amounts. Both home equity loans and HELOCs can have upfront fees.

Home equity loan against HELOC

Second Mortgage Versus Home Equity Loan: Which Is Better?

Second Mortgage Versus Home Equity Loan: Which Is Better?

What’s better, a home loan or HELOC? The answer depends on what you need to tap into your equity. For example, say you want to make some major home improvements but aren’t exactly sure how much money you’ll need. You might choose a HELOC since you’ll have a flexible line of credit that you can use as needed. HELOC has a variable rate but you hope the rates stay low over time.

On the other hand, suppose you know that you need exactly $50,000 to finance your home upgrades. You may prefer a home equity loan with a fixed interest rate instead, as this can offer more predictability in terms of payments and overall costs. The downside here is that if you go over $50,000 for your project you may have to use another loan or credit card to complete the project.

Using a home equity loan calculator or HELOC calculator can help you estimate how much you might be able to borrow and what type of rates you’ll likely qualify for. Keep in mind that, as with first mortgages, qualifying for a second mortgage can depend on your credit scores, income, and debt-to-income ratio (DTI).

The bottom line

Whether you call it a second mortgage or a home loan, it means the same thing. Taking out your equity can put money in your hand when you need the money, but consider what the cost will be and how having two mortgages might affect your monthly budget.

Mortgage planning adviceSt

  • Consider talking to a financial advisor about the pros and cons of taking out a second mortgage and whether it might be right for you. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors serving your area, and you can interview your advisors at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you reach your financial goals, get started now.

  • Your mortgage debt can play a significant role in how you plan for retirement. That’s why one of your most useful resources is a free mortgage calculator.

  • Mortgage rates are more volatile than they have been in a long time. Take a look at SmartAsset’s mortgage rate chart to get a better idea of ​​what the market looks like right now.

  • Use our free calculator to determine how much home you can afford.

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The post Second Mortgage Versus Home Equity Loan: Which is Better? first appeared on the SmartAsset Blog.

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