While the basic structure of first home loans is essentially the same across the board, second mortgages come in a variety of forms. Homeowners who suddenly need extra funds have to decide between a few different second mortgage options—the most common of which are home equity loans and lines of credit. Though both deliver the funds you need, they differ substantially, so you need to know the differences before you decide on one.
Home Equity Loans
Home equity loans (HEL) are second mortgages that work very much like your first mortgage. You receive a lump sum, which you’re required to pay off in specific amounts every month for a set number of years. The difference is generally the length—often 5-15 years, instead of a 30-year fixed rate mortgage—and the amount, which will be less and contingent on your income and current equity in your home.
Home Equity Lines of Credit
Home equity lines of credit (HELOC), instead, work more like a credit card: you’ll be approved to borrow a maximum sum and will be required to make a minimum payment each month. You can take out the whole amount at once or just a percentage, keeping the rest in reserve if the need ever arises.
Both second mortgage options tend to have lower interest rates than credit cards, because they’re borrowing against your home. They generally have a higher interest rate, though, than your first mortgage, because the added debt increases the lender’s risk.
Deciding between an HEL and HELOC depends primarily on your needs. If you’re faced with a sudden expense or want to make a large home renovation, a home equity loan will probably be a better option. If you have kids heading off to college or any other ongoing financial burden, the continuing available of a line of credit can work in your favor. Talk to your mortgage lender about which would be best for you!
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