The current interest rate environment has created a resurgence in second mortgages for homeowners. This resurgence in second mortgages is logical since taking out an additional mortgage is typically a better option than refinancing an existing mortgage to a higher rate. There are two types of second mortgages: HELOAN’s and HELOC’s.
A HELOAN is typically a closed-end second mortgage which functions very similar to that of a first mortgage. Borrowers are able to take out a lump sum of cash upfront and then make payments over a period of time to pay that lump sum back. The monthly payment is typically fully amortized, principal and interest. Interest rates for HELOAN seconds are typically slightly higher than first mortgages because they are deemed as more risky as they stand in second position.
A HELOC is an open-ended second mortgage that functions more like a secured credit card than a traditional first mortgage. A HELOC is a line of credit that has a set draw period (normally 1-10 years) where a client can take out and pay back cash as they please. A lot of the time during the draw period the borrower is only required to make interest-only payments. Once the draw period ends the HELOC converts to a repayment period where the borrower can no longer access more cash but must instead repay the outstanding balance over a fixed number of payments similar to a traditional mortgage.
Like all mortgage products, each option carries its advantages and disadvantages. HELOANs often boast a slightly lower interest rate than HELOCs and have more fixed-rate options. HELOCs give borrowers the flexibility to access cash as they need it rather than taking a lump sum. When deciding to obtain a second mortgage it is important to determine what you will need to use the cash for so you can decide on which option is best for you.
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