Any loan that’s secured with a home or other real property is a mortgage, regardless of the terminology that lenders use to sell them to homeowners, so "home equity loan" and "second mortgage" are largely interchangeable terms. Although a home equity line of credit -- or HELOC -- and a second mortgage similarly leverage your ownership in your home, the ways in which you access your funds are not quite the same.
Mortgage Basics
A mortgage is a loan that’s secured by real estate. If you fail to make payments, the lender may foreclose on the property and sell it to recapture its losses. When you take out a first mortgage, your down payment helps serve as collateral, and if you default, you’ve lost your own investment. In a second mortgage -- a home equity loan -- the amount of your loan is based on the amount of equity you have in your home. Equity is the home's value minus the balance of your mortgage..The fraction of your home that you own secures the loan. Both types of loans are secured by the value of your home.
HELOCs vs. Second Mortgages
Like traditional mortgages and home equity loans, a HELOC is secured by your home’s value. Unlike second mortgages, which provide a lump sum that you repay through a series of scheduled payments, HELOCs offer you a line of credit similar to one provided by a credit card company. You can tap this line of credit as needed and pay down the balance as necessary. HELOCs offer more flexibility than traditional home equity loans, but they are secured by the equity in your home. If you default on a HELOC, your property may go into foreclosure as with a traditional second mortgage.
Lien Order
No matter what terms your lender uses to describe a loan against your equity in your home, it’s a second mortgage and it functions as a second lien on your home. This means that should you default on your loan, the lender is second in line -- following the lender that provided your primary mortgage -- for recovery of debt secured by your property. Because of this secondary position, interest rates on second mortgages are typically higher than those on first mortgages, as it’s less likely the second lender will be paid if you default.
Cash-Out Refinance
A third option to leverage your equity in your home is a cash-out refinance. You start fresh with a new primary mortgage, which is usually taken out for the full value of your home. A portion of the new mortgage pays off the remainder of the original mortgage. You pocket the difference, minus the down payment for the new mortgage. This option essentially “reboots” your mortgage as if you are purchasing your home today. Don’t consider the cash-out equity free money, though: You’re paying interest on the amount cashed out until you achieve the same amount of equity in your home under the new mortgage.
References
Writer Bio
Wilhelm Schnotz has worked as a freelance writer since 1998, covering arts and entertainment, culture and financial stories for a variety of consumer publications. His work has appeared in dozens of print titles, including "TV Guide" and "The Dallas Observer." Schnotz holds a Bachelor of Arts in journalism from Colorado State University.