How is a Second Mortgage Different from a HELOC?

Owning a home means having the benefit of having home equity that you can tap into should the need arise. In the event of a huge financial expense that you can’t cover with just your savings, you can tap into your home equity. Examples of these high-ticket expenses are an extensive car repair, some expensive medical procedures that are not covered by insurance, home improvement and home renovation, or paying for higher education. In Canada, some of the most popular ways that homeowners use to tap into their home equity are second mortgages and HELOCs. So, how does a HELOC differ from a second mortgage and which one may be better for you?

Let’s Understand Home Equity

Home equity is your home’s current value minus any debt you have on it or remaining mortgage you still owe from your lender. This means that if your home is valued at $1million and you still owe $400,000, your home equity is at $600,000 which is 60% of your home’ value. Having home equity that is above 20% of the home’s value typically qualifies for both a second mortgage and a HELOC. Most lenders will also allow you to tap up to about 80% of that equity. For $600,000, that means you can access as much as $480,000.

What is a Second Mortgage?

A second mortgage is a home equity loan that is taken on top of having a primary mortgage. It comes as second in priority in terms of payment if you ever default and so carries more risk for non-payment. This is why second mortgages charge a higher interest than a primary mortgage. Second mortgages are dispersed as a lump sum and repaid in installments with a set sum according to terms until the entire debt and interest are paid in full.

What Is A HELOC?

A HELOC, or a home equity line of credit, involves the use of home equity as collateral for the loan but the loaned amount is made available as a revolving credit, unlike a second mortgage. With a HELOC, the homeowner is given access to funds that they can use and reuse as needed, much like having a credit card with a really high credit limit. The homeowner can take out as much as needed or even just a little amount at a time as long as the credit limit isn’t exceeded. The monthly payments are typically just based on the amount that is used up and interest is only charged for the same. With a HELOC, you can also reuse the funds after you’ve paid them back as long as the HELOC is still active. This is the most flexible option when it comes to borrowing against your home equity although may not work well for those with shopping addiction or uncontrollable spending.

How is a Second Mortgage Different from a HELOC?

Both second mortgages and HELOCs are extremely helpful for homeowners who need access to large sums of cash. Both have risks and pros that should be weighed out prior to deciding which one to get. Note that with both home loans, you will risk losing your home if you fail to honor the terms or make payments. It is best to speak to a mortgage professional to get an in-depth insight on how they differ and what may work better for you. If you’re planning to get a HELOC or apply for a second mortgage in Canada, do not hesitate to contact us.