Second mortgages explained

While it might sound like it at first, the term “second mortgage” does not always indicate that a homeowner owns multiple homes -- in fact, in most cases, it actually means that said homeowner owns just one home and has simply taken out another loan on top of their original mortgage.

These second mortgages are either home equity loans or home equity lines of credit (HELOCs), and they are taken out and repaid much like a typical mortgage is. They come with fixed or adjustable interest rates, include predetermined repayment terms (usually 10, 20, or 30-year terms), and require that homeowners prove a certain level of monetary responsibility before their loan application is accepted.

The prospect of taking out an added loan, on top of your original mortgage, may be intimidating, but for many homeowners it is a smart choice. While it might take 30 years or longer for you to pay off your house, that doesn’t mean you can’t reap the benefits of owning a valuable property before that time comes. A second mortgage allows homeowners to take advantage of their home equity; in other words, all the money you’ve already paid off and any added value your home has accrued over time can potentially be used to your advantage. Whether you’re strapped for cash and need some money to pay off immediate debt or you just want access to extra funds in case of emergency, a second mortgage could be the way to go.

Is a home equity loan or a HELOC a better choice?

There are two distinct types of second mortgages, and as each homeowner has unique goals, which is the better choice comes down to the individual. Here’s a breakdown of each option along with some examples of what types of situations they are most advantageous in:

• Home equity loans: These loans offer homeowners a one-time, lump-sum cash loan that is then repaid over a set number of years, typically with a fixed interest rate.
• HELOCs: These loans offer homeowners a revolving line of credit which they can choose to borrow from at any point during the stipulated 10-year draw period. After that point, you will pay back anything you borrowed over a set repayment period, typically with an adjustable interest rate added on top.

As you can already see, both of these loans come with their own benefits. A home equity loan is great for homeowners who have a specific goal with the cash they’re borrowing, whether it's to pay off debt or pay for a construction project, and who know how much money they want to borrow, as it will be paid out in one sum. With fixed interest rates and a definitive amount borrowed, a home equity loan is a very stable, predictable way to borrow a large sum at one time.

On the other hand, perhaps you are more interested in having access to extra funds as needed, but you aren’t sure exactly how much you want to borrow and you’d like to keep your options open. In this case, a HELOC could be the right choice because you can choose to borrow any amount of money (within the lender’s set borrowing limit) at any point during your draw period. This essentially means you'll have access to emergency funds for ten years, but you don’t have to commit to borrowing a specific, large amount all at once. After your draw period ends, you will then repay whatever you ended up borrowing, with interest added on top.

Which you should choose depends on what you plan to use the money for. If you have an immediate use in mind, look into a home equity loan. More interested in an emergency fund that you might dip into later? HELOC is the way to go.

How about a cash-out refi?

What if you can’t qualify for a second mortgage loan, or you simply don’t want to go through the hassle of applying for another loan? You still have the option of getting a cash-out refinance instead.

As we’ve already mentioned, cash-out refis are usually easier to qualify for than second mortgage loans. This is largely because a refinance is not an additional loan but is instead a replacement for your previous loan. These loans have the potential to save you money in the long run, depending on what your interest rate was on your original mortgage versus what it will be if you refinance. One of the biggest benefits a refinance has over a home equity loan or a HELOC is that it typically involves much lower closing costs and upfront fees, saving you cash at the beginning. If you are starting out this process strapped for money, this might be a factor to consider.

Making the right decision

What it all comes down to is what you can qualify for and why you plan to borrow money. Besides the differences between these loan types, each lender also has its own qualification requirements, fees, and interest rates, which all play a key role in shaping a loan experience. Before starting the process of applying for a loan, do your due diligence and write out a plan including why you want or need to borrow from your equity, what you’ll do with the money, and if you can realistically pay it back when the time comes.

Once you’ve narrowed down your personal goals in getting a loan, and you’ve used our home equity loan calculator to check just how much equity you might have available to borrow against, we recommend you check out our ratings and reviews to get an accurate picture of how lenders compare.