Home Equity Loan Vs. Second Mortgage

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The terms "home equity loan" and "second mortgage" are often confused by many homeowners. Usually a home equity loan describes credit based on HELOC--your home equity line of credit. A second mortgage is another sort of home equity loan. When looking to take a loan based on the equity accrued in your house, you must consider whether a second mortgage or a HELOC offer is the best option for your current financial situation.

What Is a Second Mortgage?

Second mortgages are very similar to the first mortgage that you used to purchase your home. The key difference for second mortgages, however, is the fact that a second mortgage is secured through the assests of your first mortgage and is based on the amount of equity that you have accrued in your first mortgage.

With second mortgages, the lender is, as a result, at higher risk, so a second mortgage will have a higher rate of interest than you would see with a first mortgage. However, a second mortgage does offer a fixed schedule with equal and predictable payments, which can make it a good option when looking for a significant sum to finance a major project, your child's education or other emergency expenses.

Home Equity Loans

Often referred to as a lump-sum loan, a home equity loan is set up in a similar manner to your first mortgage but as a second loan after your first mortgage. Closing costs on second mortgage loans will be lower than those for first mortgages. However, home equity loans have fixed rates, which are a little higher than those on your first mortgage.

Home Equity Line of Credit (HELOC)

A HELOC is a type of credit that uses your home as a form of collateral. Since your home is normally your biggest asset, many people will take a home equity loan for major purchases such as home improvement, education or medical bills.

With a HELOC, you are offered a specified credit line. In many cases, the limit is taken as a percentage of your home's value, less any outstanding balance shown on your current mortgage.

Responsibilities of Home Equity Loans

Both second mortgages and HELOCs use your house as collateral so it is essential that you only take out these loans when you are confident of your ability to repay them.

Whichever type of loan you opt for, you will often have the opportunity to deduct part of the costs of repayment when you pay your taxes. Due to the increased closing costs associated with a second mortgage, you will be able to have more itemized deductions, which is worth bearing in mind when choosing your new loan.

Choosing the Best Type of Loan

The best loan for your situation depends on a range of factors including your spending habits, credit rating, and financial requirements. It is often the case that regular payments are better suited for home equity loans, whereas one-time payments are better for second mortgages. Discuss your options with financing companies to consider which loan is the best choice financially for your situation.