Second Mortgage Versus Home Equity Loan

June 9, 2003, revised August 30, 2003 "What are the differences between a second mortgage and a home equity loan?" The terminology is confusing. A second mortgage is any loan that involves a second lien on the property. Some second mortgages are for a fixed dollar amount paid out at one time, in the same way as a first mortgage. As with firsts, such seconds may be fixed-rate or adjustable-rate. The seeds of confusion were sown in the 1980s when second mortgages appeared that were structured as a line of credit rather than for a fixed dollar amount.  Borrowers could draw up to some amount, when and as they pleased.  These loans were called "home equity loans" or "home equity lines of credit", with the latter shortened to HELOC.  They are always adjustable rate. I now avoid the term "home equity loan" and use "HELOC" to refer to any mortgage loan structured as a line of credit.  While most of these loans are second mortgages, some are first mortgages.  If you own your house free and clear and you want a line of credit secured by a mortgage, that loan is a HELOC, even though it is a first mortgage.  Similarly, if you use a HELOC to refinance your first mortgage, the HELOC becomes a first mortgage.  I avoid "home equity loan" because the term is now used to mean many different things.  Some people in the marketplace use it as a synonym for second mortgage, while others use it as a synonym for HELOC.  Regulators usually define it as a mortgage on a home that is used for some purpose other than to purchase the home.  And the National Home Equity Mortgage Association defines it as a mortgage to a subprime borrower! In terms of usage, a HELOC is most convenient when your cash needs are stretched out over time. A common example is a series of home improvements, one followed by another. College tuition payments is another. Fixed-dollar seconds are best when you need all the money at one time. Many home purchasers take out such seconds to avoid mortgage insurance on the first mortgage. When taking a fixed-dollar second, borrowers can select between fixed and adjustable rates, as they prefer. When taking a HELOC, they take an adjustable, and if they want a fixed they refinance into a fixed-dollar second after they have drawn as much as they intend to borrow on the line. Copyright Jack Guttentag 2003

Jack Guttentag is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Visit the Mortgage Professor's web site for more answers to commonly asked questions.

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