Is a HELOC or second mortgage right for me?
For many people, a home is the most significant asset they own, and this asset can provide homeowners access to funding if they need it. But what is the best way to use your home as collateral? And is it a good idea?
The first thing to understand about home equity is the different ways you can use your home to deliver a cash injection – the two primary ones are a home equity line of credit (HELOC) and a home equity loan, which is often called a second mortgage.
Home equity line of credit (HELOC)
As the name implies, a HELOC is a line of credit that a lender provides you based on the value of your home, the amount of equity you have in it and your credit score. Like a credit card, you can use as much or as little of the money available in the HELOC, provided you make the minimum monthly payments on time. Some HELOCs even come with a linked debit card so it’s easier to make purchases.
Notably, however, most HELOCs have a variable interest rate. This means that your rate, and therefore your minimum payment requirement, are subject to change, which can make it trickier to budget.
A home equity loan (second mortgage)
Unlike a HELOC, which allows you to draw out money as you need it, a second mortgage pays you one lump sum. You then make fixed-rate payments on that sum each month until it’s paid off. It essentially is the same as your first mortgage, only instead of getting a house, you get an influx of cash.
When to consider home equity financing
Typically, HELOCs are used for home improvements such as a new roof, updated kitchen, refurnished basement and other projects of that nature. This is because HELOCs give you flexibility to use as much or as little of the line of credit as needed. This flexibility lets you pay for materials and work as your project unfolds, whether you prefer weekend projects or longer term renovations.
Second mortgages, on the other hand, are generally used to pay off larger, more significant debts that you’ve already incurred. For example, if you’re in over your head with credit card debt, taking out a second mortgage to pay off all outstanding balances could help, especially if you are able to secure a better interest rate on your second mortgage repayments than you would with credit card repayments. Some small business owners also take out second mortgages on their homes to keep their company afloat during lean times. Speak with your financial professional about options that are right for you.
What to consider and how to decide
Neither a HELOC or a second mortgage should be taken lightly – although they both provide an immediate cash infusion, they both also increase the amount of debt payments you’ll owe each month. There’s also a certain amount of risk involved because these loans are secured by the house. If you don’t make your HELOC or second mortgage payments on time, you could lose your home.
If you are looking for ways to access cash, an alternate path is to consider is belt-tightening. If you can, cut back on expenses and adjust your budget so you don’t necessarily have to take out a HELOC or second mortgage.
If you’re considering a HELOC or a second mortgage, download this infographic, and talk with a trusted financial partner. He or she can help you better understand your situation and decide which option is best, or if there’s a better route to take.
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