Second Mortgage vs. Home Equity Loan: Key Differences

The terms home equity loan and second mortgage are often used interchangeably. But are the two actually the same thing? 

Well, yes and no. 

More accurately, home equity loans are a type of second mortgage, with home equity lines of credit (or HELOCs) being another common variety. A second mortgage, however, refers to a lien –– the legal claim against an asset –– taken out on a property with an existing mortgage.¹ Compared to your primary mortgage, your second mortgage will almost always be smaller, considering the loan you’re taking out is against only the equity you have accrued rather than the full property value. 

While second mortgages and home equity loans may be two sides of the same coin, it’s still worth delving into the different varieties of second mortgages –– shedding light on their differences, mechanics, advantages, and limitations. By the end of this article, you should have a clearer understanding of which option might be best suited for your financial needs and a definitive answer in the second mortgage vs. home equity loan discussion. 

Understanding Second Mortgages: Features and Benefits 

If this is the first you’re hearing of a home equity loan or second mortgage, the concept may seem foreign. Being able to transform your home's equity into a valuable financial resource without selling your home and downsizing? It might seem contradictory, but this is, in essence, exactly how a second mortgage works. With a second mortgage, you can borrow against the equity you've built up in your home, allowing you to access funds to apply toward home improvement projects, college funds, investments, debt consolidation, travel, or virtually any other purpose you can imagine. 

As mentioned earlier, there are two primary types of second mortgages: home equity loans and home equity lines of credit. But while home equity loans and HELOCs are both types of second mortgages, their differences are worth noting. Home equity loans work by providing homeowners with a lump sum payment, typically at a fixed interest rate, potentially making it easier to plan for regular monthly payments over a set period. HELOCs, on the other hand, function more like a credit card –– giving you a credit line from which you can borrow as needed throughout an established draw period before repaying your loan. 

This repayment period is perhaps the most notable factor to consider when researching second mortgages and home equity loans, as your chosen loan product will significantly impact the repayment process. With a home equity loan, your monthly payment is fixed over a set period, determined by your interest rate and the amount of equity you decide to take out. But with a home equity line of credit, your interest rate will likely be variable with a multi-phase repayment period, which can lead to some unexpectedly large monthly payments. Discover more on a HELOC vs. home equity loan in our guide.   

Unraveling the Mechanics of Home Equity Loans 

Given the predictability that stems from a fixed interest rate and unchanging monthly payments, home equity loans are the popular choice for homeowners seeking a clear-cut, one-time infusion of funds. Home equity loans are in much higher demand now than they have been in recent years, as homeowners look for ways to combat the effects of inflation.² In fact, some even use a home equity loan to pay off debt. But just because home equity loans are the popular choice doesn’t mean they’re always the right one, and understanding the finer details of how these loans work is crucial. 

Applying for a Home Equity Loan

To access home equity via a home equity loan, homeowners complete an application much like they would with a primary mortgage. If approved, you’ll have the opportunity to borrow against your available home equity –– and then use this equity however you see fit. As a second mortgage, the application process for a home equity loan is quite similar to that of a primary mortgage, with potential lenders assessing your creditworthiness and financial stability before approving the loan. In this case, however, lenders will also ask that you provide information about your home's value, the amount of equity you have, and details about the mortgage itself to process your application.   

Once approved, you will receive a lump sum, and your repayment process begins as it would with any loan. But unlike your primary mortgage, a home equity loan is secured against the property. Meaning: If you fail to make regular payments and end up defaulting on the loan, the lender can take action to recover their funds. Despite all the benefits of a home equity loan, this risk is often too great for some homeowners. But as we will discuss later, there are other, safer ways to access your home equity.  

When to Consider a Second Mortgage Loan: Scenarios and Advantages 

Whether you choose to pursue a home equity loan or a home equity line of credit, the decision to take out a second mortgage should be driven entirely by your short- and long-term financial goals and your current circumstances. Below are a few instances where a second mortgage loan might be the right choice. 

• Home Improvements: By increasing your home’s value, you, in turn, increase your home equity. A second mortgage can free up the cash needed to tackle costly repairs, take on home improvement projects that have been waiting in the wings for years, or drive up your home’s price through value-adding renovations of all shapes and sizes. Both home equity loans and HELOCs can make these dreams a reality, but proceed cautiously to ensure you don’t take out more equity than you need. 

• Debt Consolidation: If you, like many Americans, are haunted by high-interest debts, a second mortgage can be a great way to consolidate these debts into a single loan –– providing a lower interest rate and saving money in the long run. Both types of second mortgages support this strategy, but the variable interest rates associated with HELOCs can lessen their effectiveness. 

• Education Expenses: Through a second mortgage, homeowners can tap into their home equity to finance self-improvement initiatives –– like starting a business or getting an education. Whether you’re working toward your first degree, pursuing an advanced certificate, or funding an education for your child or a loved one, home equity loans and HELOCs can make this dream a reality. Just be sure that the interest payment on your second mortgage is lower than those found in federal and private educational loan options. 

• Emergency Situations: Life often throws curveballs at us when we least expect it. And while financial experts recommend having an emergency fund to cover these unforeseen expenses, recent data shows that only 20 percent of Americans currently have an emergency fund.³ If you find yourself in this situation, a second mortgage can provide a safety net –– provided you use only the equity you need to keep food on your table and remain in good financial standing. 

Leveraging Your Home Equity: Advantages and Limitations 

When used wisely, your home equity can help you improve your home’s value, achieve your goals, and even finance the education you’ve always dreamed of. But for every advantage that comes with accessing your home equity via a second mortgage there is an equal –– or even greater –– potential disadvantage. As discussed above, the obvious advantages include the possibility of lower interest rates compared to personal loans and credit cards. A surprising advantage of a second mortgage, however, is that the interest you pay on a home equity loan might be tax-deductible, depending on your financial situation and the laws in your area.⁴ Is a home equity loan tax deductible? Learn more in our guide. 

The limitations, on the other hand, include adding to your debt load by borrowing against your home equity: the product of years or even decades of on-time payments and hard work. Most crucially, however, is the risk you assume by leveraging a second mortgage. Depending on your circumstances, these limitations might far outweigh the advantages, making it all the more crucial that you carefully weigh the pros and cons before inking an agreement on a home equity loan or home equity line of credit. 

Deciding on a Second Mortgage: Factors to Consider

We’ve outlined the risks, benefits, and possibilities associated with second mortgages, but ultimately it’s up to you to decide if this financial tool is right for you. So, as you ponder this question, consider the following: 

• Purpose: How will the funds from your second mortgage be put to use? If you’re planning on using a lump sum for a home renovation project, a home equity loan might be more geared toward your needs. But for ongoing, unpredictable expenses, the flexibility of a HELOC may be the better option. 

• Interest Rates: The fixed interest rates associated with home equity loans offer stability, while a HELOC’s variable rates may come with some initial savings but can rise over time. Research and compare interest rates for both options before making your decision.  

• Repayment Terms: It’s important that you understand the repayment terms of each option –– as the nuances of home equity loans and HELOCs can vary significantly.

• Risk Tolerance: No matter which type of second mortgage you consider, inherent risks are involved when borrowing against your home equity. Assess your comfort level with the risks associated, and consider the potential consequences should your financial situation change.

• Financial Outlook: A second mortgage can impact the next five to 10 years of your financial future –– with lingering effects lasting even longer –– meaning you should take a holistic view of your financial situation before proceeding with a second mortgage. Will you have a consistent income to cover payments? Are you planning to sell your home in the near future? How will a second mortgage impact your long-term financial goals? Carefully consider these questions to ensure you’re making the right decision. 

Truehold’s Sell and Stay Transaction: The Popular Second Mortage Alternative 

Second mortgages –– be they in the form of a home equity loan or home equity line of credit –– allow homeowners to leverage their home equity to accomplish major financial and personal goals. And while these financial tools each come with their fair share of risks, you can navigate these by carefully weighing the advantages, disadvantages, and your own personal circumstances before making a decision. But if you feel that a second mortgage still doesn’t align with your goals, or if the risks simply aren’t worth it, you might discover that Truehold’s sell and stay transaction is the perfect fit.  

Whereas a second mortgage allows you to borrow your home equity, and then repay it plus interest over the next decade or two, Truehold’s sell and stay transaction puts your equity in your hands –– free and clear. By selling your home to Truehold, you unlock your home equity and continue living in your home as a renter.

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Sources: 

1. Rocket Mortgage. What Is a Second Mortgage and How Does it Work? https://www.rocketmortgage.com/learn/second-mortgage 

2. USA Today. Home equity line of credit and home equity loans: ‘Right tool at the right time’.  https://www.usatoday.com/story/money/2022/11/10/home-equity-line-credit-applications-surged/7999537001/ 

3. Bankrate. Bankrate’s 2023 annual emergency savings report. https://www.bankrate.com/banking/savings/emergency-savings-report/#key-stats 

4. Rocket Mortgage. Can You Decuct Second Mortgage Interest On Your Taxes? https://www.rocketmortgage.com/learn/can-you-deduct-second-mortgage-interest