Second Mortgage vs. Home Equity Loan: What's Better?

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When trying to decide which is better, second mortgage vs. home equity loan, you will need to keep in mind what you will be using the loan for, because there are differences in the interest rates and how and when they are paid off.

Second Mortgage

A second mortgage is a lump sum loan amortized like your first mortgage. It is simply a second loan behind your first mortgage and the closing costs are generally lower than they were on your first. This type of loan is similar to your first mortgage when it comes to the interest rate and offers a fixed rate. It can be used for one-time purchases, such as a large home improvement project or the restructuring of your debt. The interest rate is usually higher than the rate on your first mortgage, but the qualification process isn’t as daunting as when you first purchased your home. You will need to document your income and your credit must be good in order to qualify for this type of loan, but beware of loans offering zero or no-equity that allow you to borrow up to 125 percent of the home’s value. The zero and no-equity types of loans tend to have stricter qualifying standards and the interest rate will be higher.

Home Equity Loan

A home equity loan, otherwise known as a home equity line of credit (HELOC), will offer an adjustable rate of interest and is used for purchases over time, such as college tuition payments or multiple home improvement projects. Often, you will find that a second mortgage is referred to as a home equity loan, which can cause confusion as to which type of loan you obtain. Be aware of this terminology and read the fine print if it is truly a second mortgage you want rather than a line of credit. The HELOC loan offers a variable rate of interest, continuous use of funds, and future amortization. Often, you will be given a credit card to access the funds of a HELOC and there will be a limit to how much you can use, depending on your qualification and the property value of your home.

Which Is Better?

Both types of loans can reduce your debt, and a second mortgage interest is tax deductible. When considering any type of second mortgage or home equity loan, take into careful consideration the amount you need because you do not want to deplete all of your home’s equity. Also, be sure that the combination of the two loans does not go beyond 90 or 95 percent of your home’s value because when you decide to sell your home, you will want the debt you have accrued covered by the sale of your home.

Both loans will have a payment plan attached to them, and the term will depend on which you choose. The HELOC offering future amortization will be due upon the end of the predetermined period. Consider what your needs are, and then shop around to find the lender best suited for you.