Ask Dr. Don By Don Taylor, Ph.D., CFA • Bankrate.com

Home equity vs. second mortgage

Dear Dr. Don,
What is the difference between a home equity line and a second mortgage?
Carol Ann Creditwise

Dear Carol Ann,
A home equity line of credit (HELOC) is a second mortgage, but a second mortgage isn't necessarily a home equity line.

A line of credit is a commitment by a lender to lend up to the amount of the line over the term of the loan. A mortgage is a secured loan backed by the value of your home. The home equity line of credit is a mortgage because it's backed by the value of your home.

Like a first mortgage, a second mortgage is secured by the value of the home, but the holder of the second mortgage isn't entitled to any proceeds from the sale of the home until the first mortgagee has been paid. So the commonality between the home equity line and the second mortgage is the second-in-line status of the lender.

HELOCs and home equity loans are both types of second mortgages because the loans are secured by the home's value. So a second mortgage can be either.

A HELOC is a more flexible form of financing than a home equity loan because the homeowner can borrow up to the line of credit, pay the balance down and borrow the money again over the term of the loan agreement. In contrast, a home equity loan is for a defined amount and repaid in equal payments over the loan term.

Home equity loans have a fixed interest rate. HELOCs are variable-rate loans where the interest rate fluctuates with changes in the interest rate of the index that the loan is based upon. For example, the interest rate on many HELOCs is based on the prime lending rate. Changes in the prime rate will trigger changes in the HELOC's interest rate.

-- Posted: April 4, 2002