HELOC Vs. Second Mortgage: Which Loan Type Is Right For You?

When it comes to financing your home, the terminology can sometimes be incredibly confusing. If you’re looking to extract value from your home, there are cash-out refinances, home equity loans and home equity lines of credit (HELOCs). If you’re trying to understand a HELOC vs. a second mortgage, it’s helpful to know that they’re really one and the same.

Second Mortgage Vs. HELOC: What’s The Difference?

A HELOC is really a type of second mortgage, but it’ll be easier to understand once we break down the details.

What Is A Second Mortgage?

The best place to start our explanation is probably what a second mortgage is. A second mortgage refers to another lien applied to a home that already has a first or primary mortgage on it. Rather than referring to a specific financing option, the term second mortgage refers to a category of loans.

The most common use for these is to access existing equity in your home without having to refinance your primary mortgage. That would be done with a HELOC or a home equity loan, depending upon your situation. Some down payment assistance is also a second mortgage in the form of a forgivable, deferred payment for more traditional installment loan.

What Is A Home Equity Line Of Credit (HELOC)?

A home equity line of credit (HELOC) is a second mortgage that works like a credit card, at least initially. Rather than receive the funds all at once, you’re approved for a funding line that you can access at any time. During this draw period, you can take funds out and put them back as many times as you want to pay for whatever you wish. You only owe the interest payments.

After the draw period comes the repayment period for your HELOC. During this time, the existing balance freezes and you owe both principal and interest over the remainder of your term.

A HELOC serves a similar purpose to, and is often confused with, a home equity loan. The home equity loan is another form of second mortgage, with the key difference being that you get all the money from your converted equity upfront, as you would with a cash-out refinance. Rocket Mortgage^® offers Home Equity Loans, but not HELOCs.¹

Pros And Cons Of A HELOC

If you’re considering this avenue for financing, you should know there are many pros and cons of HELOCs.

Pros

Here are several of the benefits of a HELOC:

• Borrow money as needed: If you’re looking to get projects started and you don’t know exactly how much you need, the line of credit aspect to this could be very attractive. You can take money out and only pay back the interest or put the money back in to be utilized many times during the draw period.
• Lower closing costs: HELOCs tend to have closing costs around 2% – 5% of the amount of the credit line. This can be lower than some other options you might have to access your home equity or get another loan. Part of the reason for this may be that there are lower costs associated with a HELOC. As an example, a lender may rely on an already existing appraisal.
• Flexible repayment period: Lenders offer draw and repayment periods of various lengths, so you may be able to more easily find an option that gives you the funding you need while fitting your budget.

Cons

While the benefits deserve acknowledgment, it’s also important to be wary of potential drawbacks:

• Temptation to overspend: If you don’t have a specific budget in mind, having a line of credit might entice you to spend more than you originally intended.
• Risk of foreclosure: Because your house is used as collateral for a HELOC, the house is at risk of possible foreclosure. If you default on the payments.
• Variable interest rates: Because they function similarly to a credit card during the draw period, these have variable interest rates. These can change as often as every month depending on what’s happening in the market.
• Possibility for payment shock: Because you go from only interest payments being required during the draw period to paying for principal and interest during the repayment period, you have to be prepared for your installments to go up quite a bit in the latter part of the term.

HELOC Alternatives

A HELOC can be a great option for many looking to find cash to fund projects or other pursuits, but there are alternatives available:

• Home equity loan: A home equity loan might be a good alternative when you don’t want to touch your primary mortgage and you have a budget set already. Like a cash-out refinance, you get the funds in a lump-sum payment.
• Cash-out refinance: A cash-out refi involves refinancing your primary mortgage with a new interest rate and term and taking out a bigger balance. You only have one mortgage payment. In this scenario, it’s important to do the math and see what makes the most sense for you. We’ll get there in a minute.
• Personal loans: These are shorter-term loans where approval is solely based on your past credit history. That means you don’t have to worry about collateral, but also know that your rate will be higher based on lender risk. The other big upside of this option is fast approval.
• Credit card: You have to be careful about this because credit cards have the highest interest rates of any option we’ll cover based on it being a rolling balance every month. But if you can find a credit card with high enough limits and pay it off by the end of the billing cycle, you won’t pay the interest. Additionally, you may be able to be approved for a card at an introductory 0% annual percentage rate (APR). These tend to last up to a few months, which could give you more time to pay off a larger balance.

How To Pick The Right Financing For You

If you’re considering using a HELOC for a remodel, the first thing you need to decide is whether it would be better to take a second mortgage or do a cash-out refi. In order to know that for sure, have a Home Loan Expert help you with a blended rate calculation. To start, you just need to tell them how much you looking to borrow.

In a blended rate calculation, the lender will calculate the weighted average interest rate you would pay if you kept your existing primary mortgage and took out a HELOC or home equity loan to fund your home improvements. If the weighted average rate is lower than the rate you would receive by taking a bigger primary mortgage balance, you should do the second mortgage. Otherwise, the cash-out refi would be better.

If you determine a second mortgage is the way to go, then you must decide between a home equity loan and a HELOC. The HELOC may be good if you’re planning multiple projects and putting the money back in over time without a set budget. If you do know the cost of your potential improvements, a home equity loan may make sense because the rate can be fixed.

The Bottom Line

A HELOC is one type of loan in the broader category of second mortgages. Specifically, a HELOC is a line of credit with variable interest rates that freezes after a number of years to be paid back with principal and interest. This contrasts with home equity loans or cash-out refinances where you get the money upfront.

While Rocket Mortgage doesn’t offer HELOCs, we do offer both Home Equity Loans and cash-out refinances. If you’re interested, get started with the approval process!

^! Home Equity Loan product requires full documentation of income and assets, credit score and max loan-to-value (LTV), combined loan-to-value (CLTV), and home equity combined loan-to-value (HCLTV) ratios. Requirements were updated 2/5/2024 and are tiered as follows: 680 minimum FICO with a max LTV/CLTV/HCLTV of 80%, 700 minimum FICO with a max LTV/CLTV/HCLTV of 85%, and 740 minimum FICO with a max LTV/CLTV/HCLTV of 90%. Your debt-to-income ratio (DTI) must be 50% or below. Valid for loan amounts between $45,000.00 and $500,000.00. Product is a second standalone lien and may not be used for piggyback transactions. Product not available on Schwab products. Guidelines may vary for self-employed individuals. Some mortgages may be considered “higher priced” based on the APOR spread test. Higher priced loans are not allowed on properties located in New York. Additional restrictions apply. This is not a commitment to lend.