The reasons to consider a second mortgage are many, as are the programs available to you once you make the decision to tap into your home equity. Some popular reasons for taking out a home equity loan include paying for college tuition, debt consolidation, covering needed medical expenses, and financing a home improvement project. Before you start shopping around, however, you should decide whether you want a closed-end second mortgage home equity loan (HEL) or a home equity line of credit (HELOC).
A closed-end second, also known as a home equity loan, refers to a second mortgage that is structured in a very similar way to your first. With a HEL, you choose a fixed amount that you want to borrow, close on the loan, and receive a check for the amount you have chosen. You have regular monthly principal and interest payments that are structured over a period of years. Upon completion of those payments, your home equity loan will be paid in full. If you decide later that you would like to draw additional funds, you will need to arrange for an additional loan with additional closing costs. HELs usually carry a fixed interest rate. HELs offer a straightforward plan for paying the money back.
A HELOC, on the other hand, is a line of credit from which you can withdraw money again and again. In many ways, a HELOC is just like a credit card, but the interest you pay is tax-deductible. You will close on a HELOC only one time, but if you decide after a few months that you need to withdraw additional money, you will be able to do so up to the value of the loan. That is to say, if you close on a HELOC for $60,000 and over a period of time pay back $13,000 toward the principal, that $13,000 is available to be drawn again at any time. HELOCs offer payment flexibility not available on HELs; you can make interest only payments for a number of years on a HELOC.
Whether a HEL closed-end second mortgage or a HELOC is right for you is something you should discuss with your loan officer and with your financial planner. If you are relatively sure that you will need to borrow against your equity only one time in the next several years, for some kind of expense with a fixed cost, a HEL makes sense, as it offers the fixed rate and regular amortized payment schedule that ensures you know both how much your payment will be and how long it will take you to pay off the loan. This kind of assurance can be particularly useful if you do not trust yourself to spend wisely, or if you tend to buy impulsively and do not want the option of drawing out additional funds.
A HELOC can be most useful if you are taking on a project, such as home repair, that has the potential of unforeseen expenses. A HELOC offers you the flexibility to borrow again and again. Your HELOC will likely have a low interest-only payment allowing you to borrow more and still have a manageable payment amount each month. Whichever you choose, drawing against the equity can allow you to borrow at far lower costs than you can borrow with an unsecured loan. Also, the interest you pay on any type of home mortgage is tax-deductible, offering an additional incentive.
Be cautious, however, about the amount that your borrow in an equity loan. If you ever default on a home equity loan, you put your house at risk.
Consult with your loan officer and financial planner to decide whether an HEL closed-end second mortgage or a HELOC would best suit your needs. Examine all the costs associated with the loan and do some thorough comparison shopping. If you do your homework and review all the options available, you will be well on your way to finding the right equity loan for you.