Tom Kelly: Second mortgage or line of credit

We have discussed that increasing home prices, coupled with increased incomes, have provided consumers with more household wealth and equity in their homes. Some have used the additional income to pay down their mortgages faster.

Lenders are offering low-cost home equity loans to borrowers. If you have a home remodeling job that’s been on the back burner or a tuition bill about ready to eclipse your savings account, you’ve probably thought about a home equity loan. Make sure you understand the difference between programs and how home equity funds are dispersed.

There are two types of home equity loans – the conventional second mortgage and the home equity line of credit, or HELOC. A second mortgage provides you with a lump sum of money repayable over a fixed period of time while a home equity line of credit gives you a credit line you can tap into whenever you wish. Let’s check some basic differences.

A home equity line of credit is more flexible. With a line of credit, the borrower can tap into the fund whenever needed. If you plan to use the money for recurring debt, such as medical bills, tuition payments or a rather large home improvement project, a home equity line of credit is usually the better choice.

A second mortgage is more predictable and conservative. If you are naturally conservative and like the idea of knowing you have borrowed a specific amount of money and will pay it back in specific amounts each month for a set number of years, then a second mortgage might be a better option for you.

Second mortgages are usually fixed rates; equity line rates adjust. One of the biggest negatives with second mortgages when compared to lines of credit is that second mortgages usually come with an interest rate greater than a home equity line of credit. That’s because second mortgages come with fixed rates, while equity lines offer lower initial rates in exchange for the borrower assuming the risk of a changing market. If market rates rise, so does the rate on the line of credit. HELOCs typically adjust monthly or quarterly.

Second mortgages offer less temptation. Second mortgages do not allow a borrower to pay down, and then retap into a seemingly endless pool of credit, thereby reducing the tendency to overspend and stretch out the repayment. With a home equity line of credit, borrowers often purchase items they don’t really need and often regret buying when it’s time to repay the debt.

If you plan to use the money to set up a new business, buy an investment property or loan a sibling a lump sum for an emergency, financial experts say a conventional second mortgage is probably the better way to proceed. It’s wise to double-check the amount needed because applying for additional funds later can be expensive and problematic.

If you plan to use the money to pay for Mom’s periodic medical bills, your child’s tuition payments or a wedding, a home equity line of credit is usually the better choice. Again, the HELOC allows you to tap into a credit line only when you need it.

Before entering into any home equity loan, be honest about how you spend and repay your debts. If you have a history of maxing out credit cards, will you max out your credit line and then be stuck with no other way to repay it?

Make sure any second mortgage goes toward a special project or event. You do not want to be paying for a frivolous shopping spree with money from the roof above your head.