HELOC or Second Mortgage

Home Equity Line of Credit or Second Mortgage
Which is Better?

Most people probably consider these types of mortgages as interchangeable. They both tap into whatever equity you have in your house. However there are some important differences.

Second mortgages had a bad reputation with those who lived through the Great Depression. They were the cause of the loss of many a homestead.

Second mortgages were mainly used by homeowner to finance home improvements and there were a lot of unethical deals made.

Banks didn’t push them very hard for a while. At one point it seemed that bankers were actually concerned that people preserved the equity in their homes.

That concept has gone out the window in the lenders’ rush to boost profits at just about any cost. They no longer seem concerned about whether you can afford to keep you house or not. Some will lend you up to 125% of its actual value.

This has all come back to bite the lenders in the butt, but that's another story.

The Home Equity Line of Credit (HELOC) was one of the banks’ first attempts to make second mortgages respectable again. Once the public accepted them, the plain old second mortgage or "Home Equity Loan" was easy to swallow.

A HELOC is a revolving line of credit based on the equity in your home. It is secured by a mortgage and usually carries a variable interest rate that is initially lower than that charged for a second mortgage.

As you make payments on your loan, you line of credit is restored and you can use it over again. Usually you can draw on this line of credit for about ten years, at which point the balance is converted into a regular second mortgage that is amortized over the next ten or 15 years.

A second mortgage or Home Equity Loan is for a fixed amount, say $10,000. While it can carry a variable rate, you are better off with a fixed rate. It can run from 5 to 30 years – whatever the bank is willing to do. Since you can’t draw on the loan, you are actually paying it off from the very beginning.

Both types of loans have valid uses. For example, a parent might use a HELOC to cover shortfalls in their children’s educational financial aid. Or it can be used for home improvements, investments, down payment on a second home, etc. The list is endless.

The problem arises when the HELOC is used to buy a car, pay for a vacation or finance a shopping spree. It’s very easy to do, just use the checks the bank gives you. You might even have an ATM card to help you obtain quick access to your money.

It is not very wise to go into debt for 20 years or so to pay for two weeks in Cancun this winter. That goes for any use of the HELOC for depreciating assets. Don’t forget that house values can go down, leaving you with little or no equity when it comes time to sell.

So unless your are disciplined, if you want money for college or a home improvement, it would be better to stick with the plain old second mortgage. The reason is simple: less risk and no temptation. Don’t play games with your biggest asset.

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