What Is the Difference Between a Home Equity Line and a Second Mortgage?

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Since a home equity line and a second mortgage are both attached to your home, many people have difficulty telling the two loans apart. In reality, both are additional mortgages on your home. The difference between the two is how the loans are paid out and handled by the bank. Technically, a home equity line is a second mortgage since it is a second loan taken out against your home.

How Does a Home Equity Line Work? 

A home equity line is a revolving line of credit.

The bank opens the credit line and the equity in your home guarantees the loan. A revolving line of credit means that you can borrow up to a certain amount and make monthly payments. The payments are determined by how much you currently owe on the loan. Once you have paid off the money you can borrow it again without applying for another loan. It is similar to a credit card in that way. It is important to remember that you miss payments on your home equity loan, you do put your home at risk. This is why you should avoid using it to pay off your credit cards or other debt.

How Does a Second Mortgage Work?

A second mortgage is also attached to your home. It operates differently, though. The loan is paid out in one lump sum at the beginning of the loan. The payment amount and the term (length) of the loan are already set. Once the loan is paid off, then you would have to open up a new loan to borrow against the equity in your home again.

Many people will use a second mortgage as a down payment on the home to avoid PMI. They may also take out a second mortgage to cover home repairs or to pay off debt. As with a home equity loan, if you miss payments on this loan, you can lose your home.

Which Option Is Better for Me?

People use both of these types of loans for a variety of reasons.

One common reason is debt consolidation. However, it is risky to move unsecured debt, such as credit card debt to a secured loan. It puts your house at risk if you are unable to make payments for any reason. Additionally, it cuts into the equity that you are building on your home. People may also take out a home equity loan to pay for home repairs or to go on a vacation. It is better to avoid cashing out your equity if you can. It is best to avoid borrowing against your home if at all possible.

Where Do I Put These Loans in My Debt Payment Plan?

In a debt payment plan, it is important to put a second mortgage or a home equity line in with the rest of your consumer debt. It should be paid off before you start investing seriously because the interest rates are generally higher than most first mortgages. It does not make sense to invest when you are paying that much in interest each month. The second mortgage or home equity loan may be the last item on your debt payment plan or may come before your student loans depending on the interest rate that is attached to each loan.

Should I Use a Home Equity Loan as an Emergency Fund?

Many people used to rely on home equity line as an emergency fund.

However, banks are beginning to close home equity lines, even if they have been in good standing in the past. Instead, you should work on saving between three to six months of income to cover the emergency that may come up. This puts the control of your financial stability back into your hands.When you use your home equity loan as an emergency fund, like if you were to lose your job, you put your home at risk. if you do not find a new job quickly enough, it makes managing your mortgage payment and home equity loan payment more difficult each month that you use it. As the balance of the loan grows so will your payment, which increases the risks of defaulting on the loan. This should be a last resort when it comes to your finances.