When you own a home, you may build equity over time, which can be used for various purposes such as home renovations, consolidating debts, or funding a child’s education. One way to access your home’s equity is through a home equity loan or a second mortgage. In this article, we will compare these two options and help you decide which one is best for you.
Home Equity Loan
A home equity loan is a loan that uses your home as collateral. It is also known as a second mortgage since it is a second loan that you take out against your home. This type of loan allows you to borrow a lump sum of money based on the equity you have built in your home. You then repay the loan over a fixed term, usually between 5 and 30 years, with a fixed interest rate.
Pros of a Home Equity Loan:
Fixed Interest Rate: One of the advantages of a home equity loan is that you have a fixed interest rate. This means that your monthly payments will remain the same throughout the life of the loan, making it easier to budget and plan for.
Lump Sum Payment: A home equity loan provides a lump sum payment that you can use for any purpose you choose, such as home improvements or debt consolidation. This can be a good option if you have a large expense coming up and need the money upfront.
Tax Deductible: The interest paid on a home equity loan may be tax deductible. This can help to reduce your tax bill and make the loan more affordable.
Cons of a Home Equity Loan:
Collateral: As with any secured loan, your home is used as collateral. This means that if you are unable to make your loan payments, the lender may foreclose on your home.
Closing Costs: Like any mortgage, a home equity loan comes with closing costs, which can add up to several thousand dollars. This can make the loan more expensive than you originally anticipated.
Interest Rate: While a fixed interest rate can be an advantage, it can also be a disadvantage. If interest rates drop, you will be stuck with a higher rate, unless you refinance the loan.
A second mortgage is similar to a home equity loan in that it is a loan that uses your home as collateral. However, instead of borrowing a lump sum of money, you are given a line of credit that you can draw from as needed. You then repay the loan, with a variable interest rate, over a fixed term, usually between 5 and 30 years.
Pros of a Second Mortgage:
Flexibility: A second mortgage provides more flexibility than a home equity loan. With a line of credit, you can borrow only what you need, when you need it. This can be a good option if you have an ongoing expense, such as home renovations, or if you want to have access to cash for emergencies.
Lower Closing Costs: A second mortgage typically has lower closing costs than a home equity loan, making it a more affordable option for some borrowers.
Interest Deductible: As with a home equity loan, the interest paid on a second mortgage may be tax deductible.
Cons of a Second Mortgage:
Variable Interest Rate: The interest rate on a second mortgage is usually variable, which means that it can go up or down over time. This can make it difficult to budget and plan for your monthly payments.
Collateral: As with a home equity loan, your home is used as collateral for a second mortgage. If you are unable to make your loan payments, the lender may foreclose on your home.
Potential for Overspending: With a line of credit, it can be tempting to borrow more money than you need, which can lead to overspending.