Home Equity Loans and Second Mortgages: Is there a difference?

A second mortgage is any loan where 1) your house is used as collateral in case you default on the loan, and 2) you already have a primary or "first" mortgage that's also based on the value of the home.

When you use a mortgage to purchase a home, that's your "first mortgage." Subsequently, you may decide to take out a home improvement loan or a home equity line of credit (HELOC). Since you already have one mortgage on your home, these home improvement loans that come later are "second mortgages."

Second mortgages mean increased lender risk

Because second mortgages or home equity loans are riskier for the lender, they generally carry slightly higher interest rates than you would expect to pay for a first mortgage. They represent more risk because if you stop making payments, the lender who holds the first mortgage gets paid before the lender who holds the second.

Types of second mortgages

In practice, there's no difference between a second mortgage and a home equity loan. But there are different types of second mortgages/home equity loans, and depending on which one you choose, you'll have different payment terms and home equity loan rates. For example, a HELOC works much like a credit card. You have a line of credit, and only pay interest on the amount you borrow. Once you pay off your balance, the interest stops accumulating. With a home equity loan, you borrow a lump sum and pay it back over time, the way you would for any other installment loan.

The good news is that you don't have to worry too much about the glossary of terms, because when you apply for a loan, your banker or mortgage loan officer will explain them clearly to you. The main thing to understand is that, when applying for a second mortgage, you have many choices. Make sure to shop around and learn as much as you can before picking the one that's right for you. That way, you'll ace this major test in your financial life.