For those that are not in the mortgage industry, a loan closing package can be an overwhelming process to complete, which is often why it’s been said that a mortgage is one of the most stressful financial situations to go through, must worse than buying or leasing a car. While a professional can help walk through the loan parameters and specific rate and terms when an application is in process, it’s good to know a few basics before you start the process. You may hear the terms “HELOC” and “mortgage” thrown around, but do you really know the difference?

Defining a Mortgage

A mortgage is defined as a lien on a property which is secured by a party, a mortgage company, that lends funds in order to purchase the home. If you were to stop making payments and default on the loan, the lienholder would be in first position to take over the home and sell in order to recoup the cost. A mortgage can have a fixed or adjustable rate, with terms that range from typically ten to thirty years, with a loan amount on what you can afford that is based on approval of your credit, income, and assets, which is essentially your ability to repay the loan.

Adding a Second

As you build up equity on the property, the mortgage balance decreases while the home value either stays the same, or hopefully continues to rise each year. The difference between what you owe vs. what the home is worth is the equity you have built up. If you would like to draw from those funds you can borrow against your home in the form of a second mortgage. Because this lienholder is in second position, they would get paid after the first mortgage is recouped. A second mortgage can be in the form of either a home equity line of credit or a home equity loan, and while both are using your home as collateral, they are each different products that you will have to decide if home equity loan rates fit your needs.

Home Equity Line of Credit

This line of credit works like a credit card, where you receive a set line amount that you can borrow against and only pay the balance on what you borrow. The loan rates are usually variable, which is a wide range based on the market rates, making the HELOC able to adjust the monthly payments accordingly. In either equity situation, a borrower is able to borrow usually up to 80%, so let’s say your home is worth $200,000 and you owe $100,000 on the mortgage, the loan-to-value would be 50%, and you would be able to pull 30%, or $60,000 out.

Home Equity Loan

The other option to borrow from is the home equity loan, where it works more in line with a first mortgage, with a set loan amount, rate, and terms. Your maximum amount to borrow is still up to 80%, but at least you don’t have to worry about fluctuating rates and can live with a set monthly payment for the entire terms of this second mortgage.