Home Equity Line of Credit vs. Second Mortgage: What's the Difference?

Do you have home repairs or improvements on your to-do list? If you do, you might be wondering what your options are when it comes to financing.

At Addition Financial, we hear from a lot of homeowners who believe they can increase the market value of their homes by undertaking some remodeling and repairs. We work with them to help them get the money they need to move forward.

In this post, we’ll review the two most common options. The first is a home equity line of credit, and the second is a second mortgage. Each option has its merits.

What is a Home Equity Line of Credit?

A home equity line of credit, or HELOC, is a popular option for homeowners who want to undertake renovations or home improvements. These things can help you increase the market value of your home and, down the line, they can help you get a better purchase price than you would without them.

A home equity line of credit has several characteristics that differentiate it from a second mortgage:

  1. HELOCs are revolving lines of credit. That means you are approved for a specific amount and term, usually 15 years. You can borrow all or some of it, repay it and then borrow against it again. There is no limit on the number of times you may do this provided the line is open and in good standing.
  2. A home equity line of credit functions like a credit card. In other words, you can borrow as you need it. It’s an ideal solution if you’ll need to pay multiple contractors for the work they do on your home.
  3. A home equity line of credit may be a second mortgage – but it doesn’t have to be. Homeowners who have completely paid off their mortgage can still get a HELOC in case they need to borrow for an emergency or to make repairs.
  4. The interest on a home equity line of credit may be tax deductible, but since every situation is different, a tax professional should be consulted.

There are a lot of benefits to getting a home equity line of credit if you want to increase the value of your home.

What is a Second Mortgage?

Now, let’s talk about the characteristics of a second mortgage. They are:

  1. A second mortgage is any loan that places a second lien on your home (subordinate to your first, or primary, mortgage).
  2. A second mortgage can exist only if a first mortgage is in place. It’s meant to be an additional loan, separate from the initial mortgage you took out to pay for the house.
  3. A second mortgage is almost always distributed as a lump-sum payment. That means you’ll get a one-time payout you can use to pay off other debts, pay college tuition or put into an account for home repairs.
  4. Like the interest rates for a home equity line of credit, the interest for a second mortgage may be tax deductible. Your tax professional will help you make that determination.

Some homeowners who get a second mortgage may choose to use the funds to pay off their first mortgage if the interest rates are lower or they have only a limited amount left to pay.

The Refinancing Checklist for a Savings-Oriented Homeowner

The Differences between a Home Equity Line and a Second Mortgage

The primary difference between a home equity line of credit and a second mortgage is the way the funds are distributed.

A second mortgage is always distributed as a lump-sum payment. Depending on what you intend to do with the money, you may choose to have the bank disburse funds directly to a contractor. Or, you may choose to place the money in an account where you can use it to pay off debts, pay contractors or pay for your child’s college tuition.

By contrast, home equity lines of credit act as revolving credit accounts, as we mentioned above. The money remains at the lending institution until you decide to draw down on it.

Since a HELOC is a revolving line of credit, it might help to think of applying for one as similar to applying for a credit card. When you draw down on the line, you’ll be required to make regular monthly payments. The amount due will vary based on your utilization.

The takeaway here is if you just bought your home with a minimal down payment or have limited equity in it, you may not qualify for a second mortgage or a HELOC. However, some homebuyers are approved at the time of getting a mortgage. Each situation is unique, so ask your lender whether a HELOC is right for you.

The choice between a home equity line of credit and a second mortgage will depend on your circumstances and why you need the money. For home repairs, many homeowners prefer a HELOC because of the flexibility it provides.

If you’d like to learn more about Addition Financial’s second mortgage and HELOC options, please click here now.

Topics:

Mortgages