Home Equity Loan vs Second Mortgage – Full Comparison

Wondering about a second charge mortgage? Don’t worry; many people are in the same boat. In fact, each month, over 6,900 people visit our website for advice on secured loans.

In this article, we’ll explain:

• What a second charge mortgage is and how it works.
• The true cost of a bad second charge mortgage.
• The good and bad points of a second charge mortgage.
• How to ask for a second charge mortgage.
• Ways to make your credit score better.

We know you might be worried about the details of a second charge mortgage. But, with the right help, you can get a second charge mortgage even if your credit score is not great. This article is here to guide you.

Home equity loan vs second mortgage

Home equity loans and second charge mortgages are both used as a way to borrow a lump sum – sometimes substantial amounts – using the equity in your home. Common reasons for borrowing against the equity in your home is to complete home renovations or for debt consolidation. 

But that leaves the question: should you use a home equity loan or should you use a second charge mortgage? Is there even a difference? 

What are the benefits of a second mortgage?

A second mortgage benefits a homeowner needing a loan in many ways:

1. It allows them to borrow against their home’s equity
2. The money is paid out as one lump sum
3. Loan amounts from second mortgages can be used as the homeowner wishes without restrictions. As mentioned, most use the money for renovations and consolidating debts. 
4. Borrowing against equity can help them borrow larger amounts that other credit options (discussed later)
5. Using equity as collateral could help the homeowner access competitive mortgage interest rates. However, second mortgages are typically more expensive than a first mortgage. 
6. First mortgage providers usually offer second mortgages as well, meaning there are many options.

What are the benefits of home equity loans?

For those needing credit with home equity available, there are many benefits of home equity loans, such as:

1. These loans enable homeowners to borrow against their equity
2. The money is paid to the homeowner in one large payment
3. They potentially allow the homeowner to borrow large amounts that may not be available through another type of personal loan, especially unsecured options.
4. You can use the money for any purpose you wish
5. Because the loan is secured with home equity, you can find competitive interest rates compared to unsecured credit. 

What is the downside to a second mortgage?

As with all credit options, a second mortgage also has its disadvantages. When you take out a second mortgage, you risk being forced to sell the property if you do not pay it back as agreed with the lender. 

It will also take you longer to pay off both mortgages, meaning it will probably take longer for you to own the property without any debt attached to it. Moreover, if house prices fall, you’re at risk of negative equity where you’re paying more to buy the property that it is currently worth. 

Another drawback is the loan fees and closing costs you’ll have to pay by opening a second mortgage. Because this is a separate debt not tied in with your first mortgage, you may have additional fees and charges to pay. 

What is the downside of a home equity loan?

The major downside of a home equity loan, aside from putting you at risk of foreclosure, is that it comes with additional loan fees and charges, not least the closing costs. These costs can be hundreds or even thousands of pounds, depending on how much you borrow. 

Similar to a second mortgage, it’s likely to take you longer to pay off the debts and own the home outright, and it does increase exposure to negative equity. 

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How much can you borrow on your second mortgage or home equity loan?

When you use a home equity loan or second mortgage, you borrow against home equity only. It is the equity that secures the credit agreement and therefore the equity is what determines how much you can borrow. 

It is unlikely that the lender will allow the homeowner to borrow against all of their home equity as this is risky for everybody. If the property decreased in value then the homeowner could get themselves into negative equity due to borrowing against too much of their equity. 

Most lenders will allow homeowners to borrow against a maximum of 85% home equity in either of these products. This percentage is known as a loan to value (LTV) ratio, i.e. the loan amount against the value of the security (home equity). Your loan to value ratio may be affected by income, existing debt and your credit score. 

This means if you have £100,000 equity, the loan could be around £85,000 at most. Some lenders may also apply minimum loan amounts of around £10,000. 

Is a home equity loan considered a second mortgage?

If you hadn’t noticed already, a home equity loan and a second charge mortgage work in identical ways. They both allow the homeowner to borrow against their home equity as a separate debt to their initial mortgage. And the homeowner can use the loan amount as they wish. Both options are frequently used to renovate homes, which can actually increase their value and increase home equity again. 

Even the pros and cons of these products are similar, if not exactly the same!

It is for these reasons that many people consider a home equity loan as a type of second charge mortgage. You can find plenty of articles online where experts refer to second charge mortgages as a mortgage but also as an umbrella term for home equity loans and home equity line of credit (HELOC). We explain the latter towards the end of this guide. 

What is the difference between a second mortgage and home equity loan?

So, if even experts consider them the same, are there any differences between second mortgages and home equity loans? Well, on the whole not really. You might have to go to different types of lenders to get them. 

Second mortgages are exclusively available through lenders that are authorised to provide mortgages, which usually means speaking with a bank or building society. Home equity loans are also available through these lenders, but they may also be advertised through some online finance companies that provide other loan types.

There are bigger differences between a second mortgage and home equity line of credit, which are discussed soon. 

Second charge mortgage for all purposes

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Home equity loan vs second mortgage – which one to choose?

Because home equity loans and second mortgages are highly identical, there is no way to say which one is the best option for you. Instead, you should assess both options to look for the most advantageous repayment terms, considering the interest rate offered and any additional loan fees. 

Even if they had significant differences, it would still be difficult to tell readers which one to choose. When you are considering taking out any type of loan, the best option will be determined by your personal circumstances, finances and preferences. Sometimes a poor credit score will stop you from accessing your preferred option. 

You may also want to consider remortgaging and borrowing extra from your equity. 

HELOCs Vs second mortgages

If a HELOC has some key differences to a home equity loan, that would make it different to a second charge mortgage too. So how do a HELOC and second mortgage compare?

Some of the big differences between HELOCs and second mortgages are how the money is accessed and how repayments are structured. 

You may prefer to use a HELOC if you are renovating in stages and want to keep on top of a budget. The draw period allows you to structure loan payments in step with the project stages.

You should check interest rates and meticulously check the terms of any home equity loan, HELOC or second mortgage.