There are many benefits to owning a tangible asset, such as a home, allowing you to take advantage of rising equity in the property. One of the ways you can use this equity is to take out a second mortgage. Still, many people are unsure whether this is the best course of action. You may wonder what the differences are between a home equity loan and a second mortgage, allowing them to make an informed financial decision. We compare the pros and cons and explore whether you should do a HELOC or a second mortgage.
Second Mortgage – What You Need to Know
A second mortgage is not much different than the first one because you need to pay a lender money over time to acquire your property in your name. First mortgages have higher monthly payments with interest, meaning the second mortgage is subordinate to it and becomes a secondary priority. If you can no longer pay your mortgage, you must prioritize paying back the first lender, which means the second may not receive anything. However, second mortgages have higher interest rates because of this added risk, meaning it is risky for homeowners to opt for one.
Home Equity Loan – What You Need to Know
Home equity loans are similar to second mortgages in that you can opt for a loan based on your home’s value. You can expect to borrow between 80 and 85% of your property’s value, which is less than what you need to pay back for your mortgage. If your home’s value is $600,000 and you still owe $400,000, you can use the 80-85% rule to calculate how much you can borrow. For example, 80% of $600,000 is $480,000. This amount is subtracted by $400,000, meaning you can only borrow $80,000. You can use this borrowed sum for various expenses, such as education, medical, wedding, and debt consolidation, giving you some flexibility regarding how to use it.
HELOC vs. Second Mortgage – Comparison and Pros and Cons
Both types of loans allow homeowners to take care of their living expenses. You can tap into your property’s equity by opting for a second mortgage. A HEL provides greater payment flexibility since you can use the money for any expense. Home equity loans also have lower interest rates than second mortgages, especially if you have an excellent credit score. If you’re worried about paying off the loan quickly, you can choose the shortest payback term possible. However, a HEL provides even greater risk than a second mortgage if you cannot follow through on the payments, increasing your chances of defaulting.
When choosing between a home equity loan and a second mortgage, you should do proper research and consider your life circumstances. If you have no trouble paying back your home equity loan, it may be a better option than a second mortgage. However, if you default, you can get away with not paying your mortgage since the priority would be the first one.