HELOC vs mortgage: What's the difference?

What is a mortgage?

A mortgage is a loan that helps you finance the purchase of a home. When you take out a mortgage, you agree to repay it over a set period, typically 15 to 30 years. Each month, you'll normally make a payment towards the principal (the amount you borrowed) and the interest (the cost of borrowing the money).

Mortgage refinance

A mortgage refinance is when you replace your existing home loan with a new one. Typically, people refinance their mortgage to get a lower interest rate, which could save them money over the life of their loan.

However, some people get a mortgage refinance to tap into their home equity — the portion of their home’s value they own outright.

Second mortgage

A second mortgage is a loan that uses your home as collateral. The advantage of a second mortgage is that it may come with a lower interest rate than other types of loans, like personal loans. As a result, it can be an attractive option for homeowners looking to consolidate debt or make home improvements.

However, remember that a second mortgage is still a loan, and you will need to make regular payments to avoid defaulting and losing your home.

What is a HELOC?

A HELOC is a type of loan that also uses the equity in your home as collateral. With a HELOC, you can borrow a portion of your equity and spend it on what you like. The loan is typically structured as a line of credit, which means you can draw upon the loan funds as needed, up to the credit limit.

READ MORE: HELOC: Home equity line of credit handbook

Is a HELOC a second mortgage?

Unlike a refinance that replaces your current home loan, a HELOC is often considered a type of second mortgage.

When you get a HELOC, you are effectively taking out a second loan against your home. However, there are some key differences between a HELOC and a traditional second mortgage.

For example, a HELOC typically has a variable interest rate, while a more traditional second mortgage, like a home equity loan, usually has a fixed interest rate.

Additionally, with a HELOC, you can generally borrow smaller amounts of money over time. With a home equity loan you usually borrow a lump sum all at once.

HELOC draw periods

Most HELOCs have a draw period that may last between 5-10 years. During this time, you can borrow money against your home equity.

After the draw period ends, you'll enter the repayment period, where you’ll usually repay the outstanding balance plus interest. Understanding how draw and repayment periods work is essential to making the most of a HELOC.

Many HELOCs let you just make interest payments during the draw period, meaning you don’t need to pay any principal until the repayment period kicks in. This may give you some flexibility in how you use your HELOC.

You could use a HELOC for a one-time expense, like paying for major home repairs. Or you could use it as a revolving line of credit for ongoing costs, like funding your child's college education.

Knowing how much you can borrow and when you'll need to repay it is crucial to making smart financial decisions with a HELOC.

Main differences between a HELOC vs mortgage

Most people take out fixed-rate mortgages, which means that their monthly payments will remain the same for the life of the loan. That may make it easier to budget mortgage payments.

HELOCs usually have variable interest rates. This means that monthly payments could go up or down depending on changes in the market, the amount borrowed, and other factors.

Both mortgages and HELOCs have their advantages and disadvantages so talk to a lender to see which type of loan is right for you.

Other types of mortgage loans

If you feel like neither a mortgage nor a HELOC is right for you, there are some alternatives you may want to consider: