How Home Equity Loans (Second Mortgages) Work

What it is

A home equity loan is a fixed-rate, lump-sum loan secured by your home. You borrow a set amount at closing, receive it all at once, and repay it in fixed monthly installments over a set term. Because it is a second loan on a home that already has a mortgage, it is commonly called a second mortgage. As with any loan secured by your home, the home is the collateral. This article explains how a home equity loan works; it is not a recommendation to take one out.

How it works

A one-time lump sum. Unlike a HELOC, which is a revolving line you draw from over time, a home equity loan gives you the entire amount up front. There is no draw period and no re-borrowing — once it is disbursed, the loan simply amortizes.

Fixed rate, fixed payments. The interest rate is typically fixed for the life of the loan, so the monthly payment stays the same from the first payment to the last. Each payment covers both principal and interest, and the balance steadily declines over the term. This predictability is the main structural difference from a variable-rate HELOC: you know exactly what you will pay every month.

It sits behind the first mortgage. A home equity loan is a second lien (a legal claim against the home that ranks behind the first mortgage). Your existing first mortgage stays in place with its original rate and terms untouched — the home equity loan is layered on top as a separate loan with its own rate, term, and payment. In the event of a sale or default, the first mortgage is generally repaid before the second. Because it leaves the first mortgage alone, a home equity loan (like a HELOC) does not reset a low locked-in first-mortgage rate the way a cash-out refinance would.

How to think about it

A home equity loan is often described as suited to a one-time cost of a known amount — a single, defined expense rather than ongoing or uncertain spending — because you take the full sum at once and repay on a fixed schedule.

Key trade-offs to understand:

• Predictability vs. flexibility. The fixed rate and fixed payment remove the payment uncertainty of a variable-rate HELOC, but you also give up the flexibility to borrow only what you need over time. You begin paying interest on the full amount immediately.
• Two payments at once. Because your first mortgage remains, you now have two secured payments on the home simultaneously. It helps to look at the combined obligation, not each loan in isolation.
• Secured by your home. Missing payments puts the home at risk.

How much you can borrow is limited by combined loan-to-value (CLTV): the total of all loans secured by the home divided by its value, capped by the lender. It can be compared side by side with a HELOC and a cash-out refinance.