Second Mortgage vs. Home Equity Loan: Which Is Right for You?

If you’ve been researching ways to tap into your home equity, you may be weighing a second mortgage or home equity loan. Both let you use the equity in your home for cash, but they aren’t always the same. Knowing the difference between the two can help you get the most out of your home’s equity.

What is a second mortgage?

A second mortgage refers to multiple types of loans that use your home equity as collateral. These loans are called “second mortgages” because they are borrowed in addition to your original mortgage. Additionally, if you fail to pay them and your lender forecloses on your home, they take second priority to your mortgage. Second mortgages can be used for various expenses, such as college tuition, home improvements, or medical bills.

Loans considered second mortgages include home equity loans and home equity lines of credit (HELOCs). Second mortgage interest rates differ depending on factors like the second mortgage type, your financial health, and the lender you choose to borrow from. 

What is a home equity loan?

A home equity loan is a type of second mortgage that lets you borrow against your home equity. These loans are disbursed in one lump sum, making them a good option if you need funds to cover a set or one-time expense.

Home equity loans must be repaid by the end of a set term, which varies from lender to lender. In addition to the original loan amount, you’ll be responsible for interest payments, which often have a fixed rate. Your home equity loan rate will be affected by factors like your financial standing and the lender you choose. If you don’t repay your loan, your lender can take possession of your home to recover its losses.

Second mortgage vs. home equity loan: What’s the difference?

Second mortgages and home equity loans aren’t dissimilar. In fact, the main difference between the two is that ‘second mortgages’ is an umbrella term for multiple types of loans, while home equity loans are a specific type of second mortgage. This means that home equity loans are often correctly referred to as second mortgages, but not all second mortgages can be called home equity loans. Besides home equity loans, the term “second mortgage” can also refer to:

• HELOCs: HELOCs are a revolving, or open-ended, line of credit that leverages your home equity as collateral. You can pull from this line of credit as needed throughout an initial draw period, using either checks or a credit card attached to your account. Afterward, you’ll repay the loan, with interest, over a set term. 
• Piggyback loans: Also called an 80-10-10 loan, piggyback loans are a common way to avoid paying private mortgage insurance (PMI). PMI is avoided by reducing the loan-to-value ratio of your primary home loan. These loans are taken out alongside your primary mortgage and require two separate monthly payments. 

Pros and cons of a second mortgage

Getting a second mortgage is a big decision that can affect your finances for a long time. To make sure it’s the right move for you, consider these pros and cons of second mortgages:

Pros

• Access to large sums of cash: Second mortgages often let you borrow up to 85% of your home’s equity. This can help you cover large expenses, like medical bills or college tuition.
• Low interest rates: Compared to other types of borrowing, like personal loans and credit cards, second mortgages usually have lower interest rates. 
• Tax deductible interest: If you use the funds to buy, sell, or make improvements to your home, the interest paid on a second mortgage can be tax-deductible. 
• Can help you avoid PMI: Piggyback loans can be used in some cases to avoid paying PMI if you can’t afford a 20% down payment. 
• Multiple options: There are different types of second mortgages, each of which has advantages and disadvantages. For example, home equity loans let you borrow a lump sum of cash while HELOCs let you draw funds as needed. 

Cons

• Risk of losing your home: Taking out a second mortgage can be a risky move if you aren’t sure that you’ll have the funds to repay it. Failure to repay your second mortgage might result in your home being foreclosed. 
• Closing costs fees: Like primary mortgages, second mortgages have closing costs and other fees. This can include appraisal, title search, and home inspection fees. 
• Higher debt burden: Taking on a second mortgage can increase your debt burden, putting a strain on your finances and increasing your debt-to-income (DTI) ratio.

Pros and cons of a home equity loan

The decision to take out a home equity loan shouldn’t be made lightly. Before you start the application process, think about how these pros and cons of home equity loans could affect your finances: 

Pros

• Fixed interest rates: Home equity loans usually have fixed interest rates, which are more predictable from month to month. 
• Lump sum disbursement: With home equity loans, you’ll receive your entire loan amount at once. This is ideal for large one-time purchases or expenses.
• Tax deductible interest: Home equity loan interest payment might be tax deductible if you use the loan to pay for buying, selling, or improving a home. 
• Term options: You can take out a home equity loan with terms ranging from a few years to decades. These term options can make these loans more affordable by breaking up repayment over many months. 

Cons

• Risk of foreclosure: With a home equity loan, you risk foreclosure if you fail to repay the loan. 
• Increased debt burden: Taking out a home equity loan can increase your debt burden, tightening your budget and limiting future financial endeavors.
• Equity required: To tap into your home equity, you’ll first need to build it. Since most lenders won’t let you borrow all of your equity, you’ll need more equity than you want to borrow to qualify. 
• Not an open credit line: Home equity loans are paid out in one lump sum and aren’t revolving lines of credit. If you anticipate an ongoing or changing expense, you might be better off getting a different kind of second mortgage, such as a HELOC.