Is a HELOC a Second Mortgage or Something Else?

A home equity line of credit (HELOC) is a type of second mortgage you can take out against a property that already has a primary mortgage.

With a HELOC, you can borrow against the value of your home up to a specific amount and pay it back over time, similar to a credit card with a revolving balance.[1]

HELOCs are a type of subordinated loan because the lien holder has secondary priority for payment if the home is sold or foreclosed. 

This piece will cover the ins and outs of HELOCs and dispel some common myths about them. We’ll also compare HELOS to other types of second mortgages, like home equity loans. 

What a 'second mortgage' actually means

A “second mortgage” is simply a second loan that you secure against a home that already has a primary loan. Second mortgages are sometimes called second liens or junior liens because the lien holder for the second mortgage (the bank that gives you the loan) has secondary priority. 

This means that if the home is sold or foreclosed, the second lien holder will only get paid after the primary lien holder receives their money. 

Second mortgages are commonly used to pay for home expenses and renovations without having to refinance the primary loans. 

Since priority for debt satisfaction is lower, there is a larger risk that second lien holders won’t get paid. This is why second mortgages typically have higher interest rates than primary mortgages.

So is a HELOC considered a second mortgage?

A HELOC can be a second mortgage when you take one out on a home that already has a mortgage. According to real estate professional and mortgage broker Andrew Thake: “A HELOC is secured against your home, so it is a type of mortgage. If you already have a first mortgage and the HELOC is added behind it, then yes, it is a second mortgage because it is the second claim on the home.”

So if you still owe money to the bank on your house and take out a HELOC, it will function as a second mortgage. It’s a junior lien because the lien holder has a lower priority than the primary mortgage holder.

If you don’t have an existing mortgage on your house, then a HELOC won’t function as a second mortgage.

This distinction matters for a few reasons:

• Second mortgages are riskier, so they have higher interest rates.
• Having a primary mortgage impacts underwriting for a secondary loan.
• A second mortgage means you will have to manage two monthly payments instead of just one.

HELOC vs. home equity loan

Home equity loans are another type of second mortgage distinct from HELOCs. The primary difference between a HELOC and a home equity loan is how you access the funds.

A HELOC provides a revolving line of credit that you borrow from and repay as you go, similar to how a credit card works. Like credit cards, HELOCs typically have variable interest rates.

A home equity loan, in contrast, works more like a standard loan: You receive a lump sum and repay it in installments with a fixed interest rate. 

This structure makes home equity loans more predictable from a financial standpoint. This structure also makes refinancing a home equity loan easier.

For example, a $50,000 HELOC and a $50,000 home equity loan ultimately provide the same amount of money. But a HELOC works like a $50,000 line of credit, and the home equity loan offers a $50,000 cash lump sum.

Pros and cons of a HELOC as a second mortgage

These are the major pros and cons of getting a HELOC as a second mortgage.[1]

You can access HELOC funds when you need them, similar to a credit card. A HELOC lets you keep your first mortgage without having to refinance it, which means you can keep your current mortgage rate. And instead of paying interest on the full line of credit, you only pay interest on the money you draw from a HELOC.

On the flip side, interest rates on HELOCs are variable, so monthly payments can change periodically. It’s critical for borrowers to understand the draw period, during which you only pay interest on the HELOC; once the draw period ends (~5–10 years), you start to pay interest and principal, so payments can jump significantly at that point. And if you stop making your HELOC payments, you could end up losing your home in foreclosure.

Common misconceptions: Myth vs. fact

When considering a HELOC, it’s important to separate myth from fact. Below are some of the most common misconceptions.

Second mortgages are predatory

Second mortgages are not necessarily predatory, but they do present additional risk.

Second mortgages can be useful to finance large purchases or emergency expenses. As with any mortgage product, you need to consider your personal finances before making a commitment.

A HELOC isn’t a mortgage

Many people underestimate the financial commitment that a HELOC carries. 

“Another big misconception about HELOCs is that they are merely a flexible form of credit, not a true mortgage obligation,” says Matt Schwartz, Mortgage Broker and Co-founder of VA Loan Network. “It's a mortgage obligation, and it does have implications for refinancing or selling a home.”

HELOC terms can’t change

HELOC terms can and often do change depending on various factors. 

For example, if your home value drops, your credit line could be reduced or frozen. Requesting a higher line usually requires a reappraisal of your finances.

When a HELOC might be better than a fixed second mortgage

Despite their risks, HELOCs can be a useful financial tool if used wisely.

Because they offer flexible access to funds, they can be used for home improvement projects that may have uncertain final totals, like renovations or updates. You can easily draw more if the project goes over budget, and the increased property values can help you get a larger line of credit in the future.

Alternatively, a fixed home equity loan may be better if you want a more predictable payment timeline. Home equity loans are also generally easier to refinance because they are a single fixed sum, not a revolving balance that could change.

Ultimately, the choice depends on your tolerance for credit risk. A HELOC is riskier from a payment predictability standpoint, but the convenience in using funds is the upshot.

How to shop for a HELOC or second mortgage without getting burned

If you are looking for a HELOC or second mortgage, you need to do your research and due diligence. 

Here’s a quick checklist of things to ask about when shopping around:

• HELOC terms. Make sure you know all details about the draw period, rate structure, interest caps, and minimum payment requirements. 
• Applicable fees. Typical HELOC fees include origination and appraisal fees, as well as early closure and inactivity fees. 
• Stress test finances. Variable rates can cause payments to jump, so test your finances to see how you’d manage with a rate increase. 

The bottom line

A HELOC is a type of second mortgage that borrowers typically secure against a home that already has a primary mortgage. This second lien makes HELOC riskier from a lender's standpoint, so they tend to have higher interest rates.

This makes HELOCs better suited for homeowners with a bit more tolerance for credit risk or who have more leeway with making monthly payments.

Best Interest Financial can help you figure out if a HELOC or cash-out refinance would work best for your situation. We'll work through the numbers with you and make sure you understand your options and are confident with your choice. Get started with a free quote from Best Interest Financial today.

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