Both a second mortgage and a home equity line of credit (HELOC) are additional loans to your home that are taken on top of a primary mortgage. However, some people may be confused about what differentiates them since the term second mortgage is usually used to refer to a home equity loan as well.
The main difference between a second mortgage and a HELOC is how the loan is handled by the lender. A second mortgage distributes funds as a lump sum while a HELOC distributes funds as a revolving line of credit that is not dissimilar to how credit cards work.
How Does a Second Mortgage Function?
A second mortgage is a secured loan that is backed by home equity. It is named a second mortgage because it is a mortgage loan that goes on top of an existing mortgage loan or on top of the primary mortgage. A second mortgage allows you to borrow money from the value that represents what you still owe from your first mortgage subtracted from your home’s market price today.
Funds are released from a second mortgage as a lump sum at the start of the loan. The term of the loan as well as the amount to be paid are fixed amounts determined at the beginning of the second mortgage. Payments are done per month until the loan has been paid for. Once the second mortgage has been paid, you can get another second mortgage.
How Does a HELOC Function?
A HELOC is a revolving line of credit that can be reused as long as there is still some credit left in the credit limit. This loan is backed by home equity and so has a much lower interest rate than a credit card. Payments are only made on the amount borrowed and interest is likewise only charged for the amount used.
A HELOC typically has a 10-year draw period which is the span of time wherein the borrower can use the HELOC, pay, and reuse it again. After the draw period, any amount not paid goes into the repayment period which is usually about 20 years. If you never use your HELOC, you do not have to pay anything for it. If you only use it in the fifth year of your draw period, then you owe nothing for the first 5 years. Note that a lender may choose to freeze a HELOC if property prices start falling.
Is A HELOC or A Second Mortgage Better?
There is no straight answer to this question because what may be better depends largely on your specific circumstances. If you are on the fence about which one you should apply for, you must consider your cash flow, what you are borrowing for, and your other existing debts. We can help you assess which may be the right mortgage loan option for you at Homebase Mortgages. Contact us so we can discuss the pros and cons of a HELOC and a second mortgage as they relate to your needs.