What’s the difference between a second mortgage and HELOC?
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UPDATED: Jan 17, 2012
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While both of these loans use a borrower’s real estate as collateral, there are key uses and differences between second mortgage loans and home equity lines of credit (HELOCs). Generally speaking, second mortgage loans are best used for large and immediate purchases, whereas HELOCs are best saved for making a line of credit available to a borrower over an extended period of time.
Second mortgage loans act in a way very similar to original home loans. They can be taken out with fixed or adjustable rates, and allow borrowers to carry the loan for an extended period of time. Since second mortgages are just like original home loans, and grant a borrower an enormous sum of money upfront, they are frequently used to fund large home upgrades and improvements. It’s not uncommon for one to use a second mortgage loan for pools, spas, landscaping, and home appliances.
A second mortgage is awarded to an individual borrower on the same guidelines used for an original home loan. Lenders will look at a borrower’s income, credit rating, outstanding debt, equity, and appraised home value before determining whether or not they’ll issue a second mortgage loan to an applicant.
HELOCs, on the other hand, allow borrowers access to a line a credit for an extended period of time. Think of a HELOC as a money battery or money pool that is sitting beside a homeowner. When that homeowner needs some extra financial help, they can reach into that pool and withdraw money. They’re not charged any interest on the unused portion, so there’s little harm in letting the money sit idle in preparation for a rainy day.
A borrower qualifies for a HELOC in a slightly different manner than he would an original or second mortgage loan. Lenders usually determine an applicant’s potential borrowing limit by taking 75 percent of their home’s appraised value and subtracting the borrower’s remaining balance on the original home loan from that amount. The result will reveal the maximum potential HELOC amount a borrower can qualify for.
For instance, imagine a borrower with an appraised home of $100,000. He has a home loan with a remaining balance of $50,000. The lender takes 75 percent of the appraised value, which results in $75,000, less the remaining balance. In this example, a lender will allow the borrower to take out a maximum HELOC of $25,000.