Home Equity Line of Credit (HELOC) Versus Closed-Ended Second Mortgage - What Are The Differences?
A home equity line of credit (HELOC) and a closed-ended second mortgage are both forms of borrowing that use the equity in your home as collateral. However, there are some key differences between the two:
Structure: A home equity line of credit functions like a credit card, where you have a predetermined credit limit and can borrow and repay as needed during a specific draw period, typically 5-10 years. On the other hand, a closed-ended second mortgage, also known as a home equity loan, provides you with a lump sum upfront, and you repay it over a fixed term, usually 10-30 years.
Repayment: With a HELOC, you have flexibility in terms of repayment. During the draw period, you can make interest-only payments or choose to repay both principal and interest. Once the draw period ends, a repayment period begins, during which you must make fully amortizing payments to repay the outstanding balance. In contrast, a closed-ended second mortgage requires regular fixed payments of principal and interest from the beginning of the loan term.
Access to Funds: A HELOC allows you to access funds as needed, up to the approved credit limit, during the draw period. You can borrow, repay, and borrow again within this period. A closed-ended second mortgage provides a lump sum upfront, and you cannot access additional funds unless you apply for a separate loan.
Interest Rates: HELOCs typically have variable interest rates, which means the interest rate can fluctuate over time based on changes in the market. Closed-ended second mortgages usually have fixed interest rates, which remain constant throughout the loan term.
Interest Payments: In a HELOC, you only pay interest on the amount you borrow, not on the entire credit limit. With a closed-ended second mortgage, you pay interest on the entire loan amount, regardless of whether you use the full lump sum or not.
Purpose: HELOCs are often used for ongoing expenses or projects with varying costs, such as home renovations, education expenses, or debt consolidation. Closed-ended second mortgages are commonly used for specific purposes, such as financing a large one-time expense, like a major home improvement project or debt consolidation.
Risk: HELOCs carry more risk for borrowers due to their variable interest rates and the potential for the credit limit to be reduced or frozen by the lender. Closed-ended second mortgages have fixed interest rates, providing borrowers with more predictable repayment terms.
It's important to note that these differences may vary based on the specific terms and conditions of the loan agreement and the lending institution. It's advisable to carefully review the terms, consult with a financial professional, and consider your personal financial goals and circumstances before choosing between a HELOC and a closed-ended second mortgage.