Home Equity Loans versus Second Mortgages

A second mortgage works much like the first mortgage you took out to buy your home, except that it's "second in line" if you default and the lender needs to be repaid. This represents a slightly higher risk to a lender. As a result, you'll likely pay higher points and fees and have a slightly higher interest rate than with a first mortgage. However, since a second mortgage is predictable and offers you a fixed schedule of equal payments over a long period of time, it's an excellent choice if you need a substantial amount of money to do something like a home improvement project.

Home Equity Loans

A home equity loan works in much the same way as a mortgage, but it won't carry as many origination fees and finance charges. The equity in your home serves as the collateral on the loan, and payments are made over a period of time according to a fixed schedule. In fact, the differences between a second mortgage and a home equity loan are often a matter of semantics. Some lenders refer to a second mortgage as a loan used for purposes of adding value to your home, whereas they consider home equity loans as money borrowed for other expenditures or investments, like car purchases or tuition payments. Both types of loans have fixed rates. One advantage of the home equity loan is that it doesn't involve as many origination fees, closing costs, and processing procedures as a second mortgage does.

Security and Tax Advantages

Home equity loans and second mortgages use your home as the underlying security, so you should only assume the responsibility for these kinds of loans if you are sure you can pay them back. Regardless of which loan you choose, you'll probably be able to deduct some of the costs of repaying your loan at tax time. Because you'll pay more closing costs with a second mortgage, you'll have more opportunity for itemized deductions, which is something to consider before choosing which loan is best for you. Consult your tax planner to find out which type of loan provides the best advantages based on the methods used to calculate your year-end taxes.