When it comes to financing your home, the terminology can sometimes be incredibly confusing. There are cash-out refinances, home equity loans, and home equity lines of credit (HELOCs) that can help you get money from the value of your home. If you’re trying to understand a HELOC vs. a second mortgage, it’s helpful to know that they’re really one and the same.
A home equity line of credit (HELOC) is a common way for homeowners to borrow money against the value of their home. But it’s not always clear if a HELOC is the same as a second mortgage or not. We can say that a HELOC is a second mortgage in a few words. But homeowners should know that a HELOC is not the same as a traditional second mortgage in some important ways.
What is a HELOC?
A HELOC stands for home equity line of credit. It allows homeowners to borrow against the equity they have built up in their home.
Here’s how a HELOC works:
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Loan amounts are set by the lender based on the value of your home and the amount of equity you have.
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You can use this line of credit whenever you need to during the “draw period,” which is usually 10 years. You only pay interest on the amount you draw.
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When the draw period is over, the HELOC moves into the repayment period, which lasts for about 20 years. You can’t get any more money at this point and have to pay back the principal plus interest.
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HELOCs typically have variable interest rates, like a credit card. The rate can fluctuate monthly.
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You can draw, repay and re-draw money as you want during the draw period. This flexibility makes HELOCs popular for home repairs, renovations, education costs and more.
How a HELOC Compares to a Second Mortgage
A second mortgage is any additional mortgage taken out on a home that already has a first mortgage. The first mortgage is generally the one used to purchase the home initially.
While a HELOC is a type of second mortgage, there are some key differences:
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Payment structure: A HELOC has flexible payments during the draw period, while a second mortgage has fixed payments, like any standard mortgage loan.
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Interest rate: HELOCs tend to have variable interest rates while second mortgages usually have fixed rates.
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How you access funds: With a HELOC, you can withdraw money as needed. A second mortgage provides you the full loan amount upfront in a lump sum.
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Repayment period: A HELOC transitions from the draw period to the repayment period. A second mortgage has no draw period – you must immediately start repaying principal plus interest.
Benefits of a HELOC as a Second Mortgage
There are a few advantages to using a HELOC over a traditional second mortgage:
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Lower upfront costs: The fees to open a HELOC are generally lower compared to other second mortgage options. This makes it easier to access your home’s equity.
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Pay interest only at first: During the HELOC’s draw period, you only have to pay interest on the amount you borrow. This helps keep payments affordable.
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Flexibility: Having revolving access to funds can be helpful for managing large, unplanned expenses over time. You can borrow what you need, when you need it.
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May qualify for higher amounts: Some lenders approve borrowers for up to 90% of the home’s value with a HELOC, compared to 80-85% with a second mortgage.
Risks and Drawbacks of a HELOC
Despite their benefits, HELOCs do come with some potential downsides to keep in mind:
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Variable rates: HELOC rates can fluctuate monthly, making monthly payments unpredictable. Rates may be low now but could rise over time.
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Risk of overspending: The revolving credit access can tempt some homeowners to over-borrow. Using HELOC funds responsibly is important.
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Potential payment shock: Once the draw period ends, your required payment could jump significantly to cover principal paydown.
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Your home is collateral: Like any mortgage, failure to repay a HELOC could result in foreclosure. Your home is at risk if you default.
Alternatives to Consider
If you need to tap into your home’s equity but want to avoid some of the risks of a HELOC, here are a few options to consider:
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Home equity loan: This provides one lump sum of cash, with fixed rates and payments. Less flexibility but more predictability.
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Cash-out refinance: You could refinance your existing mortgage for a higher amount to “cash out” equity. Combines existing and new debt into one loan.
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Personal loan: An unsecured loan with a shorter repayment term. Rates are higher but you don’t risk your home.
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Credit cards: Can provide revolving access to funds like a HELOC. Downsides are much higher interest rates and lower borrowing limits.
The Bottom Line
While terminology can be confusing, a HELOC is essentially a special type of second mortgage product. It offers unique benefits like low fees, revolving credit access, and potential for higher loan amounts. However, variable rates and repayment risks need to be considered carefully. For homeowners looking to leverage equity with flexibility, a HELOC can be an attractive option when used responsibly.
What is a Home Equity Line Of Credit (HELOC)?
A home equity line of credit (HELOC) is a second mortgage that works like a credit card, at least initially. Rather than receive the funds all at once, you’re approved for a funding line that you can access at any time. During this draw period, you can take funds out and put them back as many times as you want to pay for whatever you wish. You only owe the interest payments.
After the draw period comes the repayment period for your HELOC. During this time, the existing balance freezes and you owe both principal and interest over the remainder of your term.
A HELOC serves a similar purpose to, and is often confused with, a home equity loan. The home equity loan is another form of second mortgage, with the key difference being that you get all the money from your converted equity upfront, as you would with a cash-out refinance. Rocket Mortgage® offers Home Equity Loans, but not HELOCs.1
Second mortgage vs. HELOC: What’s the difference?
A HELOC is really a type of second mortgage, but it’ll be easier to understand once we break down the details.
Does A Home Equity Line Of Credit (HELOC) Count As A Second Mortgage? – CountyOffice.org
FAQ
How is a HELOC different from a home equity loan?
A HELOC is different from a home equity loan. A home equity loan gives homeowners a lump sum, secured by their home equity. It’s often referred to as a second mortgage. Home equity loans typically offer fixed interest rates.
Are home equity loans a second mortgage?
More accurately, home equity loans are a of second mortgage, with home equity lines of credit (or HELOCs) being another common variety. But a second mortgage is a lien that is put on a property that already has a mortgage on it. A lien is a legal claim against an asset.
Does Rocket Mortgage offer HELOCs?
While Rocket Mortgage doesn’t offer HELOCs, we offer alternative financing options worth considering. A home equity loan uses your home’s equity, but not as a line of credit like a HELOC. So while homeowners can tap into the same amount of equity (85%), you receive the funds as one lump sum.
Is a HELOC considered a second mortgage?
Yes, a Home Equity Line of Credit (HELOC) is generally considered a second mortgage. This is a loan backed by the value of your home; it’s not the same as your main mortgage.
Does a HELOC count as a mortgage?
Is a HELOC a first or second mortgage?
There is a type of loan called a home equity line of credit (HELOC) that works like a credit card at first. Rather than receive the funds all at once, you’re approved for a funding line that you can access at any time.
How is a $50,000 home equity loan different from a $50,000 home equity line of credit?
That noted, HELOC interest rates are variable and can change monthly based on market conditions, while home equity loan rates are fixed and will remain the same unless refinanced by the homeowner.