Second Mortgage Vs Home Equity Loan: Key Differences

By: Aaron Robbins0 comments

When you’re looking to utilise the equity that’s built into your home’s equity, you may have come across a few different options. The most common way to unlock property value equity is through a second mortgage or a home equity loan. This prompts many prospective borrowers to query the difference between the two.

At Diverse Funding Solutions, we offer second mortgages and home equity loans, so let’s look at their key differences to help you guide your next financing decision.

The similarities between home equity loans and second mortgages

Before we look at the differences between home equity loans and second mortgages, let’s first look at the similarities between the two:

Both use equity as collateral

A second mortgage and a home equity loan both require the borrower to use their home as collateral. This means that if the borrower fails to repay the loan, the lender can typically foreclose on the home to recoup lost funds.

You can have either loan, even with an existing mortgage

Due to both types of loans relying on the equity built into your property value, you can have either a second mortgage or a home equity loan, even if you have an existing home loan on the property. This does mean, though, that if you take out a second mortgage while you have an existing mortgage, you will be left to manage two monthly mortgage payments.

Both loans are a slightly higher risk than first mortgages

However, given that second mortgages and home equity loans, both sit secondary to a first mortgage or home loan, the lender runs the risk of only being partially repaid from the sale proceeds of the property (if paid at all). In the unfortunate event that you do default on your loan, your first mortgage lender has priority over the sale proceeds of your home. This is what makes a second mortgage a bit riskier for the lender.

Second mortgages and home equity loans are generally short-term loans

Both second mortgage loans and home equity loans are generally short-term loans. While your initial mortgage will generally have repayment terms spanning a loan term of up to 30 years.

Used for similar purposes

When people look to borrow money under a home equity loan or second mortgage, it’s usually for major expenses. The equity that’s sitting in your property value could be used to fund home improvements or perform a debt consolidation (where you could roll high-interest debt, such as credit cards or a personal loan, into one new loan with a lower interest rate).

Business owners commonly use home equity loans and second mortgage loans to access extra money to put towards their business, such as to boost working capital, improve cash flow, put on staff, renovate a business premises, purchase more equipment, and more!

Differences between a second mortgage loan and a home equity loan

As you may have realised by now, both second mortgage loans and home equity loans are very similar. The differences really come down to the mortgage lender offering them and whether you’re using a private lender or major bank to access a new mortgage.

Loan to value ratio

The total loan amount for either a home equity loan or a second mortgage depends on the level of equity that you have in your property. If you already have an existing second mortgage and wish to borrow further money by using the equity in your property, then you would take out a home equity loan. This could mean that the loan-to-value ratio is much less, given that you already have two mortgages on the same property.

Interest rates

Mortgage rates between lenders (especially between traditional lending institutions and private lenders) vary greatly. Generally speaking, private lenders will offer their short-term loan products with interest rates that are calculated monthly, whereas big banks will use an annual percentage rate.

Depending on whether the lender offers variable interest rates or locks you into a fixed interest rate, this can drastically change the total cost of a second mortgage compared to a home equity loan.

Can I get a home equity line of credit?

If you don’t want to access a lump sum and instead want to draw money from your home equity as you need it, then you may want to seek out a home equity line of credit (HELOC). A HELOC, however, may only be offered at a variable rate (meaning that your interest rate could continue to climb during the loan term), and the closing costs on HELOC products tend to be much higher than second mortgages or home equity loans.

If you would prefer to access the equity in your property as one lump sum, then a standard second mortgage or home equity loan may be better suited to you.

Do I pay interest on a home equity loan or a second mortgage?

Unlike bridging loans, which can come with interest-only payments, home equity loans and second mortgages tend to be principal and interest (P&I) loans. This means that you pay off the total amount you borrowed, plus fees, over the repayment period. Your monthly payments may fluctuate if you choose a variable interest rate over a fixed interest rate.

Second mortgage vs home equity loan — which is the better option?

Before you borrow money using the equity that’s built up in the value of a property that you own, talk to a broking specialist who can work with you to find the best funding solution. At Diverse Funding Solutions, we can substantially improve your chances of accessing second mortgages and home equity loans, even for borrowers with low credit scores or with a unique financial situation.

By looking at your personal circumstances, we can work with you, whereas most lenders can leave you feeling like they’re working against you. That is the beauty in private lending, and with access to over 200 of Australia’s top private lenders, we have the upper hand when it comes to sourcing fast funds.

Either get a free quote or chat with the DFS team today!

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