Second Mortgage vs. Home Equity Loan: Is There a Difference?

What is a second mortgage?

A second mortgage is an additional loan taken out against your home’s equity on top of your primary mortgage. A second mortgage is sometimes called a “junior lien” because it’s a loan that’s subordinate to your first (or senior) mortgage. In case of default, the second loan is paid off after the first.

The two main types of second mortgages are:

• Home equity loans: A lump-sum loan with fixed interest rates and monthly payments
• HELOC: A revolving line of credit with variable interest rates and flexible payment terms

What is a home equity loan?

A home equity loan allows you to borrow a fixed amount of money against your home’s equity. You receive the funds in a lump sum and repay it over a set period with fixed monthly payments. This option is ideal for large, one-time expenses, such as home improvements or debt consolidation.

​​Lenders typically follow the 80% rule, which allows you to borrow up to 80% of the home’s total value minus what you owe on your mortgage. In some cases, a lender may increase this amount to 85% or more, depending on your credit score, financial stability, property value, and loan program specifics.

Home equity loan example

Here’s an example of how a home equity loan works. Say your home is worth $500,000, and you still owe $250,000. In a typical scenario, the most you’d be able to borrow against the equity using the 80% rule is $150,000.

Here’s how that breaks down:

• $500,000 x .80 = $400,000
• $400,000 – $250,000 = $150,000

Below is a table illustrating what your monthly payments might be on a $150,000 home equity loan using current interest rates for equity-backed loans, which are typically higher than 30-year fixed mortgage rates.

*Interest rate from the U.S. Bank

What is a home equity line of credit (HELOC)?

A HELOC functions more like a credit card. You’re given a credit limit based on your home’s equity and can draw from it as needed. Payments and interest are only due on the amount you use, making it a flexible option for ongoing expenses or emergencies.

HELOCs typically have a variable interest rate, meaning their interest rates fluctuate based on the prime rate.

HELOC example

Imagine a homeowner who wants to fund various home projects over several years. They choose a HELOC with a $50,000 limit, withdrawing funds as needed and paying interest only on the amount borrowed during the draw period, with the flexibility to repay and borrow again.

If the homeowner withdrew the entire $50,000* and later repaid it over a 30-year amortization schedule at a 10.270% variable APR, the monthly payment would be about $449.

If, instead, the homeowner was approved for $150,000 and withdrew the full amount at a 9.320% variable APR, the monthly payment would be about $1,242 over a 30-year amortization schedule.

*Estimates created using Bank of America’s HELOC calculator

Should I get an equity-backed loan?

Deciding to leverage your home’s equity through a second mortgage, such as a home equity loan or a HELOC, can be a smart financial move. However, it’s important to weigh the benefits and risks to determine if this type of loan aligns with your financial goals and situation.

An equity-backed loan can offer access to substantial funds at relatively low interest rates compared to other types of credit. But it also means putting your home on the line.

Let’s look at some key pros and cons to help you make an informed decision.

Pros and cons of having a second mortgage

A second mortgage can offer benefits like access to large sums of money and flexible payments. On the flip side, it also comes with risks such as added monthly payments and possible foreclosure. Here’s a rundown of the pros and cons:

When is a home equity loan a good choice?

A home equity loan might be the right option for you if you:

• Want to combine your debts: Roll multiple debts into one monthly payment, potentially with a lower interest rate.
• Plan to make major home improvements: Use a lump sum to pay for major renovations or upgrades.
• Need to pay for college or other education: Pay for college or other large education expenses with predictable monthly payments.
• Know the amount you need: If you have a set budget in mind, a home equity loan gives you the full amount upfront with fixed payments.

When is a HELOC a good choice?

A HELOC could be the best fit if you need to:

• Consolidate higher-interest debt: Pay off high-interest debt with a potentially lower-rate line of credit.
• Tackle an ongoing home renovation: If your project will happen in stages, a HELOC lets you borrow money as bills come due instead of taking one large lump sum.
• Cover expenses with uncertain costs: Whether you’re paying for medical bills, a business venture, or another flexible expense, you can draw only what you need instead of borrowing more than necessary.
• Buy an additional home: Use the line of credit for a down payment on your next house or to purchase an investment property.

Buying and selling a home at the same time? Consider HomeLight’s innovative Buy Before You Sell program. This modern buy-sell solution unlocks the equity in your current home to simplify and streamline the entire process. You can make a stronger, non-contingent offer on your new home and only move once.

What do lenders consider when you apply for a second mortgage?

Before you apply for a second mortgage, it’s a good idea to make sure your finances are in good shape. Lenders will look at several factors to decide whether you qualify and how much you can borrow. Knowing what they’re looking for ahead of time can help you avoid surprises and make the application process a little smoother. 

»Learn more: Before comparing second mortgage options, find out how much equity you have to work with. Enter a few details into our Home Equity Calculator to estimate your available equity and explore preliminary loan estimates.

How do you apply for a second mortgage?

Applying for a second mortgage isn’t all that different from applying for your first home loan, but it pays to know what to expect. Here’s a step-by-step look at the process so you can prepare your paperwork, compare your options, and move forward with confidence.

Alternatives to consider beyond a second mortgage

If a second mortgage doesn’t feel like the right move, there are other options worth checking out:

• Cash-out refinance: This lets you replace your current mortgage with a bigger one and take the difference in cash. It’s a good option if you want to lower your monthly payments or roll in other debts.
• Reverse mortgages: For aging homeowners, this option allows you to pull from your home’s equity without monthly payments, helpful for covering retirement expenses.
• Home equity sharing agreement: This enables you to access a portion of your home’s equity in exchange for giving a share of your home’s future value to an investor. It can be a good option if you want cash now without taking on monthly payments.

Each option has its advantages, so your choice ultimately depends on what you need and what you’re comfortable with. Taking the time to explore your options can help you land on the best fit.

Which loan type to choose?

The right loan for you ultimately depends on how you plan to use the money, how much you need to borrow, and how you prefer to repay it. If you want a lump sum with predictable monthly payments, a home equity loan may be the better fit, while a HELOC offers more flexibility for ongoing or uncertain expenses. Taking the time to compare your options can help you borrow with confidence and avoid surprises down the road. 

Before you apply, it’s also a good idea to find out how much equity you have to work with. HomeLight’s Home Value Estimator gives you a quick estimate of your home’s current value, making it easier to gauge your borrowing power. Try it today to get a better sense of your home’s worth and take the next step toward choosing the loan that’s right for you. 

Header Image Source: (Pascal Bernardon/ Unsplash)