Generally, lenders offer two types of second mortgages:
- A fixed-rate home equity loan provides a lump sum to the borrower that must be repaid over a specific time, just like a first mortgage. Your loan payments and interest rate will remain the same until the loan is repaid.
- A home equity line of credit (HELOC) is a variable-rate loan with a set spending limit and a specific repayment date. You can borrow money from this line of credit with a credit card or checks, and when you pay down the balance you will have ongoing access to the credit line. Your monthly payments will vary according to the amount you borrow and the current interest rate.
Financial goals and home equity loans
Some of the most common reasons people apply for a home equity loan are to consolidate debt and to make home improvements. In both of those cases, a home equity loan is the better option because you are likely to need all the loan proceeds at once.
If you intend to use your home equity in order to have funds liquid for an emergency or to pay recurring expenses such as college tuition, a HELOC may be a better option.
Home equity loans and debt consolidation
While a home equity loan and line of credit typically offer lower interest rates than credit cards and the interest on these loans is tax-deductible up to a loan amount of $100,000, you should carefully consider the consequences of borrowing against your home. If you cannot repay the loan, you risk a foreclosure. Another common problem is that you might not be a good manager of money, and might be tempted to take on additional debt after the original credit card debt has been consolidated.
Careful evaluation of your goals and the repayment plan can help you make the right choice between a home equity loan and a HELOC.
Michele Lerner contributed to this answer
A 25-year expert observer of the mortgage and consumer debt markets, Keith Gumbinger has been cited in thousands of articles covering a wide range of consumer finance and economic topics in outlets ranging from the Wall Street Journal to the Bottom Line newsletters. He has been a featured guest on national broadcasts for CNN, CNBC, ABC, CBS and NBC television networks and has been heard on NPR and other national and local radio programs. Keith is the primary researcher and writer for HSH.com's MarketTrends newsletter and has authored or co-authored a number of consumer guides on mortgages, home equity, refinancing and more.