You probably hear the terms home equity loan, home equity line of credit (HELOC) and second mortgage used interchangeably. Some people always call a HELOC a second mortgage, while others don’t.
So what is a second mortgage, and why do people call home equity loans and HELOCs second mortgages?
First Mortgage, Second Mortgage
When banks make loans, there’s usually collateral involved. That’s what the bank takes back if the borrower doesn’t pay back the loan. With a car loan, it’s the car; with a mortgage loan, it’s the home.
A mortgage, then, is technically any loan for which the home is the collateral. Usually, the loan the buyer takes out to buy the home is called the first mortgage.
Home equity loans and home equity lines of credit are also mortgages, because the home is the collateral. So are they both second mortgages? Not necessarily.
A home equity line of credit is often called a second mortgage because the borrower almost always has a first mortgage.
A home equity loan may be called a second mortgage, but only if the borrower still has that first mortgage in place. If the borrower has already paid off the first mortgage, a home equity loan that he or she takes out is simply a mortgage.
Which Type of Second Mortgage (or First!) is Right for You?
When you borrow funds against your home equity, you can use them for home improvements—but you don’t have to. There are many uses for home equity loans and HELOCs, after all. The right choice for you depends on what you’re borrowing for.
With home equity loans, you borrow a set amount of money at a (usually) fixed rate. Your payment is generally the same every month. These loans are a good choice when you’re funding a major purchase all at once, such as when you are consolidating several debts or paying for a home renovation or wedding with one lump sum.
With a home equity line of credit, on the other hand, you get approved for a maximum amount, and then you draw on it only when you need to. You use a special credit card or checks to draw on the line, and your payments depend on what you’ve drawn. So if you need to make several major payments, a HELOC might be the better choice. They come in handy if you have to pay several contractors at different times for a home renovation, for example, or pay for college expenses over several semesters.