Second Mortgage vs. Home Equity Loan: Understanding the Differences
For homeowners looking to access the equity in their home, second mortgages and home equity loans are two popular options.
When referring to a second mortgage vs. a home equity loan, you’re really talking about the same thing. A home equity loan is a type of second mortgage on a home that’s secured by the underlying property. But, it’s not the only type of second mortgage available.
It can be a bit tricky to differentiate, so let’s break down the distinctions between a second mortgage and a home equity loan below.
What Is a Second Mortgage?
A second mortgage is an additional loan taken against a property that is already mortgaged. Depending on the type of second mortgage, the funds can be taken out all at once, or as needed over time.
Second mortgage loans are secured by the same property as your primary mortgage, but it is considered subordinate, meaning it falls into second lien position behind your first.
If you default on a second mortgage, your primary mortgage lender is paid first from the proceeds of the sale of your property. Only after the first loan is paid off will the second mortgage lender be paid back any lent funds.
Because of this added risk, second mortgages often come with higher interest rates than primary mortgages.
Types of Second Mortgages
Home Equity Loan (HEL): Provides a lump sum with a fixed interest rate and fixed monthly payments. This type of second mortgage is ideal for homeowners who prefer predictable payment schedules.
Home Equity Line of Credit (HELOC): Works like a credit card, allowing you the flexibility to borrow up to a certain limit as needed. HELOCs often have variable interest rates, which can fluctuate over time.
Common Uses for Second Mortgages
Debt consolidation
Funding major home repairs or renovations
Covering significant expenses like education or medical bills
Wedding expenses
Vacation expenses
What Is a Home Equity Loan?
A home equity loan is a type of second mortgage that allows you to borrow a lump sum against the equity in your home. When you take out a home equity loan, you are accessing the equity in your home by borrowing against its value.
The loan amount is typically determined by the difference between your home’s market value and the outstanding balance on your primary mortgage. Most lenders typically permit you to borrow up to 80% of your home's appraised value, minus the remaining balance on your first mortgage. In some cases, lenders may extend this limit to 85%.
Here’s an example of how a home equity loan works:
Suppose your home is valued at $450,000, and you still owe $250,000 on your mortgage. Using the 80% rule, the maximum amount you might be able to borrow against your home equity would be $110,000.
Here’s how the calculation breaks down:
Home Value X 0.80 = Total Available Loans
$450,000 × 0.80 = $360,000
Total Available Loans - Current Mortgage = Home Equity Loan Maximum
$360,000 − $250,000 = $110,000
This means you could access up to $110,000 in equity through a home equity loan, assuming your lender follows the 80% rule and you qualify for the payment.
Key Features of Home Equity Loans
Fixed interest rates, offering stable and predictable payments.
Loan terms generally range from 5 to 30 years.
Often used for large, one-time expenses such as home improvements or debt consolidation.
How a Home Equity Loan Differs From a HELOC
A home equity line of credit (HELOC) is another type of second mortgage loan. Like a home equity loan, it’s secured by your house and allows you to access your home’s equity.
But there are some differences in how the two work.
A HELOC is a revolving line of credit that allows you to borrow funds as needed during a specified draw period, typically up to 10 years. Once the draw period ends, the loan transitions into a repayment phase, which can last up to 20 years. During the repayment period, you’ll pay back the amounts you borrowed, along with any accrued interest.
A HELOC typically comes with variable interest rates, whereas home equity loans are more likely to offer fixed rates. Some lenders offer a fixed-rate HELOC, where you can get the benefit of a draw period along with an interest rate that doesn’t change, regardless of you accessing the line of credit multiple times.
Important note: Both home equity loans and HELOCs may involve upfront fees.
Second Mortgage vs. Home Equity Loan: Is There a Difference?
The terms “second mortgage” and “home equity loan” are often used interchangeably, leading to some confusion.
As you can tell by now, whether you call it a home equity loan or a second mortgage, the two are very similar. A home equity loan is simply a specific type of second mortgage.
Similarly, a home equity line of credit (HELOC) also falls under the category of second mortgages.
However, there are a few characteristics that differentiate a home equity loan from a second mortgage.
Loan Structure
A second mortgage includes both fixed-rate loans and HELOCs with variable rates, offering either lump sums or revolving credit lines.
A home equity loan provides a lump sum with fixed repayment terms and interest rates.
Interest Rates
Second mortgages, especially HELOCs, may have variable rates, which can change over time.
Home equity loans typically offer fixed rates, which provide stability.
Repayment Terms
Second mortgages may have more flexible repayment options, especially for HELOCs.
Home equity loans generally require fixed monthly payments over a predetermined term.
Usage Flexibility
Both loan types can be used for various purposes, such as home improvements or debt consolidation. However, HELOCs offer greater flexibility due to their revolving credit nature.
Pros and Cons of Second Mortgages
As with all types of loans, second mortgages come with both advantages and disadvantages.
Pros
Lower interest rates - Second mortgages use your home equity as collateral, which generally means lower rates, especially compared to unsecured loans like personal loans or credit cards.
Flexibility - Since a HELOC comes with a credit limit (similar to a credit card), you can borrow funds as needed, helping you avoid taking on more debt than necessary. Using only a portion of your credit line can help keep your monthly payments manageable.
Faster funds for any purpose: Unlike a student loan or automobile loan, your funds can be used however you choose. Because the closing process is typically quicker for a second mortgage than a cash-out refinance, you may be able to access the funds faster should an emergency require immediate cash.
Potential tax benefits: Interest may be tax-deductible if the loan is used for home improvements.
Cons
Higher interest rates - Although lower than unsecured loans, personal loans and credit cards, second mortgages typically have higher rates compared to a first mortgage.
Risk of foreclosure - A second mortgage uses your home as collateral. You risk losing your home if payments aren’t made.
Variable rates for HELOCs - Your rate and payment may increase if interest rates rise.
Home value could decline - Although real estate is usually considered a sound investment, there’s no guarantee your home’s value will continue to appreciate. If the housing market declines, taking out a second mortgage could leave you owing more your home is worth.
Qualification requirements: You may need higher credit scores for favorable terms.
Choosing the Best Type of Second Mortgage
When to Choose a Home Equity Line of Credit
A HELOC might be the right choice if:
You need flexibility to borrow as needed. Because HELOCs are revolving lines of credit, your credit limit is replenished as you pay down your balance (during the draw period).
You have large expenses, such as home repairs, but you’re unsure of the amount you’ll need to borrow.
You want to avoid refinancing your primary mortgage, especially if you have a super low rate on your first loan.
When to Choose a Home Equity Loan
A home equity loan might be the better option if:
You need a lump sum of money for a one-time expense, including debt consolidation, home improvements and higher education.
You prefer the stability of fixed payments and a predictable interest rate.
You want a straightforward loan structure without the ongoing complexity of a HELOC.
You want to avoid refinancing your first mortgage, especially if you have a favorable rate on your first loan.
Tax Deductions for Second Mortgages and Home Equity Loans
The interest on both mortgages and home equity loans can be tax-deductible in some instances.
According to the IRS, “Interest paid on a loan secured by your main home or second home may be deductible, subject to certain dollar limitations, only if the proceeds of the loan are used to buy, build, or substantially improve the taxpayer’s residence.”
The tax law requires that funds be used to "buy, build, or substantially improve" the home securing the loan. As such, personal expenses like paying off credit card debt do not qualify.
Consult a tax advisor to understand how these deductions may apply to your situation.
Check out our guide to the 3 home improvements with the best ROI.
How to Qualify for a Second Mortgage or Home Equity Loan
To qualify for a second mortgage in the form of a home equity loan or a HELOC, you’ll need to meet a few key requirements.
Credit Score: Credit score requirements vary from lender to lender, but second mortgages typically require a higher score than a first mortgage, especially for favorable rates and terms. A good credit score of at least 620 or higher improves your chances of approval and better rates.
Home Equity: You generally need at least 15-20% equity in your home. The maximum you can borrow is typically 85% of your existing equity.
Income and DTI: Lenders evaluate your income and debt-to-income ratio to ensure you can handle additional payments. Most lenders want to see a debt ratio at or below 43%.
Appraisal: A property appraisal may be required to determine the current market value of your home.
Second Mortgage and Home Equity Loan Alternatives
If you can’t qualify for a second mortgage, or perhaps just don’t want to take on an additional mortgage payment, you may want to consider other options.
Cash-Out Refinance
A cash-out refinance involves replacing your existing mortgage with a new one, often at a lower interest rate than a second mortgage, while borrowing more than what’s needed to pay off the current loan. The original mortgage is fully paid off, and you receive the extra funds as a lump sum at closing.
Personal Loan
A personal loan isn’t tied to the property, so it doesn’t put your home at risk, though they often come with higher interest rates. A personal loan is granted to borrowers based on their creditworthiness (not collateral).
Reverse Mortgage
If you're 62 or older, a reverse mortgage may be an option to help you pay off your mortgage, supplement your income, or cover other expenses. This type of loan allows you to convert a portion of your home’s equity into cash without selling your property or taking on additional monthly payments. However, a key risk of a reverse mortgage is that it reduces your home equity over time, potentially leaving you with a larger debt balance, which could impact the inheritance passed on to your heirs.
The Bottom Line
Both types of second mortgages–home equity loans and home equity lines of credit– offer viable ways to access your home’s equity.
While both of these loan programs allow you to borrow against the value of your house, they differ in structure, purpose, and terms. Understanding these differences can help you make an informed decision that aligns with your financial goals.
HELOCs provide flexibility, while home equity loans offer stability and predictability. Before deciding, consider factors like interest rates, repayment terms, and your ability to manage additional debt.
