Home Equity Loans & Second Mortgages Explained

What a home equity loan is

A home equity loan is a closed-end second mortgage. You borrow a specific amount, receive it in full after closing, and repay it in regular installments over a set schedule. Most home equity loans carry a fixed rate, so the payment stays the same from the first month until the loan is paid off.

Because it is a second mortgage, it sits alongside your existing first mortgage rather than replacing it. Your current loan keeps its balance, rate and schedule. The home equity loan is a separate account with its own payment and, often, its own lender.

Closed-end vs open-end second mortgages

The phrase second mortgage covers two products. A home equity loan is closed-end: one disbursement, one schedule, and the account does not reopen as you pay it down. A home equity line of credit is open-end: you draw from a revolving limit and can borrow again as you repay.

The closed-end structure trades flexibility for certainty. You pay interest on the full amount from the start, but you know exactly what you owe each month and when the debt ends.

Lien position explained

Every loan secured by a home holds a place in line. The first mortgage is in first lien position and is repaid first from any sale or foreclosure. A home equity loan is usually in second position, repaid only after the first lien is satisfied.

That second position carries more risk for the lender, which affects pricing and underwriting. It also matters to you later. If you refinance your first mortgage, the second lender generally must sign a subordination agreement to stay behind the new first loan. If they will not, the second mortgage may need to be paid off as part of the refinance.

Combined loan-to-value

Lenders decide how much to offer by looking at combined loan-to-value, or CLTV. They add your first mortgage balance and the proposed home equity loan, then compare the total with your home's appraised value. Each lender sets a maximum CLTV, and that limit can vary by occupancy, property type and credit profile.

In plain terms, the more equity you have built, the more room there may be for a second loan. If your home's value has risen or your first mortgage balance has dropped, your available equity grows.

When a home equity loan beats a HELOC

Choose a lump sum when the amount is known. A roof with a signed contract, a single tuition bill or a one-time debt payoff are good fits. A fixed rate shields you from market swings, and there is no draw period ending in a sudden payment increase. If you value a steady budget and a firm payoff date, the closed-end loan is easier to plan around.

A HELOC may fit better when costs are uncertain or spread across many months, since you pay interest only on what you draw.

When a home equity loan beats a cash-out refinance

A cash-out refinance replaces your entire first mortgage. If your current first mortgage has terms you would not want to lose, a home equity loan lets you borrow without giving them up. Closing costs apply to the smaller second loan rather than to a whole new first mortgage.

A cash-out refinance can make more sense when your first mortgage terms are no better than what a new loan may offer, or when you want a single lien and payment instead of two.

Costs and fine print

Home equity loans usually have closing costs, which may include a valuation, title search, recording fees and lender charges. Some lenders absorb certain costs but may ask you to repay them if you close the loan early. Ask about prepayment terms before you sign.

Interest on a home equity loan may or may not be deductible depending on how you use the funds. Talk to a tax professional before you assume any of that interest is deductible.

Getting started

Know the amount you need, gather your first mortgage statement and income documents, and list any existing second liens. Programs vary by borrower, property and lender, and every loan is subject to credit approval. Pick your state and city to see local details and reach a licensed loan officer.

Talk about home equity loans

A licensed loan officer can walk through your options. Programs vary by borrower, property and investor.

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Home Equity Loans & Second Mortgages