Many of us have a lot of our net worth tied up in our homes. Indeed, the equity that is built up in a home can be a source of funding when needed. If you have equity in your home, you might be considering tapping it to make home improvements, consolidate debt or pay for your child’s wedding.
Most people, when deciding to access the equity in their homes, choose either a HELOC or a second mortgage. Depending on what you are planning, one might work better than another for your situation.
When to Use a HELOC
You should note that a home equity line of credit (HELOC) is actually a type of second mortgage. However, we often think of it as something different. This is due to the characteristics of a HELOC. Instead of receiving a lump sum, you end up with an approved credit amount.
You can access the money as you need it, much as you would access a line of credit on a credit card. Some HELOCs even come with linked debit cards so that it is easy to access your line of credit.
HELOCs can be useful, however. One of the most common uses for the home equity line of credit is the home improvement loan. This is because it allows you the flexible to borrow as much — or as little — as you need. If you end up needing more money, you can get it from your line of credit (if there is still an availability) without having to re-apply for another mortgage loan.
Using a HELOC makes sense when you aren’t sure exactly what you will need, or if you want a low initial rate and you can pay off the loan quickly.
When to Use a Second Mortgage
In some cases, though, it makes sense to use a second mortgage that provides you with a lump sum. If you know exactly how much money you will need, as for debt consolidation or to contribute to a child’s college education, a lump sum can be helpful.
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dThe second mortgage is also helpful if you know that you will be paying off the loan for a long time.
In many cases, it is possible to get a fixed interest rate on a lump sum second mortgage, so you don’t have to worry about rates rising and forcing a higher payment later on. There's also advantages of paying off the second mortgage by using credit cards for rewards points.
Things to Know about HELOCs and Second Mortgages
You will often be able to deduct the interest you pay on a HELOC or a second mortgage. Check into the possibilities so that you can get this benefit if you decide to turn the equity in your home into cash.
It is vital to remember that both HELOCs and second mortgages are loans on top of your first mortgage.
This means that you will have an extra payment to make. You want to know that you can truly afford your house payment with the addition of another mortgage payment. If you don’t want another mortgage payment, you can attempt a cash-out refinance to tap your equity without having to contend with two separate mortgage payments.
You are using your ownership in your home as collateral, and you could lose your house if you fall behind in your payments. Home equity lines of credit and second mortgages can be helpful, but you should consider all your options before deciding to take the plunge.
This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.