1 Thought on Can anyone explain the difference between a second mortgage and a home equity loan?
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    January 31, 2014 at 9:37 pm

    A Home Equity Line of Credit (HELOC) is a floating line of credit that the lender provides to the borrower. For example, let’s say you take out a HELOC for $ 30,000. You must pay at least the interest that accrues every month. Let’s say that you pay it down to $ 10,000 (so you’re only accruing interest on the unpaid principal balance). Then you decide that you need an extra $ 5,000 to make some home repairs (or go on vacation). You are free to borrow another $ 5,000. The unpaid principal balance can go up and down for as long as the bank provides the borrower with this line of credit. As long as the borrower makes the minimum payments, the bank is happy since it collecting interest every month.

    Unlike a HELOC, the unpaid principal balance typically goes in one direction (down). It does not fluctuate. In other words, the bank wants you to pay the mortgage off over a specific number of months or years. If you want to take out more money (as you did with the HELOC), then you must refinance the loan (i.e., you pay off the old loan and take out another loan with a higher principal balance which may be referred to as a “cash-out refinance”). Like any mortgage, if you default, then the lender repossesses the collateral (in this case, the home). What makes a second mortgage a second mortgage is that it is in a less powerful position than the lender who made the first mortgage (this is referred to as “lien position”; the “first lien” vs. the “second lien”). If the borrower stops making payments, then the lender in the first lien position gets compensated first. If there’s anything left over (after the property is liquidated), then the second lien holder gets compensated.

    Since the holder of the second lien (the second mortgage) has more risk than the holder of the first lien, the interest rate of the second mortgage will always be higher than that of the first lien. (Higher risk requires a higher return.)

    Your confusion is understandable. Generally speaking, the difference may just be technical (as described above). It may be fair to say that all HELOCs are second mortgages but not all second mortgages are HELOCs.

    Hope that makes sense.

    Good luck!

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